Inflation in Emerging and Developing Economies: Evolution, Drivers, and Policies

http://www.worldbank.
org/inflation
Inflation in Emerging
and Developing Economies
Evolution, Drivers, and Policies
Editors
Jongrim Ha, M. Ayhan Kose, and Franziska Ohnsorge
Advance Praise for Inflation in Emerging and Developing Economies
Many emerging market economies experienced a remarkable decline in inflation

rates over the last two decades, after years of seemingly intractable high inflation.
Ha, Kose, and Ohnsorge offer the first book-length analysis of this remarkable
achievement, asking how it happened, what it tells us about best policy
frameworks, and whether it will endure. At a time when global financial
conditions pose a challenge to emerging-market currencies and monetary
policies, this book is an essential guide to the road ahead. All students of the
global economy will want to read it carefully.
Maurice Obstfeld
Economic Counsellor and Director of Research
International Monetary Fund
A remarkable resource for anyone interested in inflation in the modern world,

clear and easy to follow. This book is an order of magnitude more
comprehensive than anything else out there, not only in its country coverage,
but in its exploration of all the major issues and debates surrounding inflation.
Curiously, most of the existing academic literature has focused on advanced
economies—which are also thoroughly covered here—yet there is so much to be
learned from the dramatic inflation decline in emerging markets and low-income
economies, including for design of advanced economy institutions. Any student,
academic researcher or policy economist who wants to understand the big
picture on world inflation, and when and where it might surprise in the future,
will find this book fascinating.
Kenneth Rogoff
Thomas D. Cabot Professor of Public Policy
and Professor of Economics
Harvard University
This is an important and timely contribution to our understanding of inflation

and the causes of the synchronized decline in the second half of the 1990s
around the world. Compared to previous research, it distinguishes specific
features of the inflation process in advanced economies, emerging market and
developing economies, and low-income countries. It provides many policy
insights such as discussions on anchoring inflation expectations and the
determinants of exchange rate pass-through, two central issues for price stability.
The book reminds us that achieving low inflation does not imply that the risks
of high inflation have disappeared and presents policy lessons to achieve and
maintain price stability. I am certain that this would be a valuable reference for
scholars and policy makers.
José De Gregorio
Dean of the School of Business and Economics, Universidad de Chile
Former Governor of the Central Bank of Chile
Advance Praise for Inflation in Emerging and Developing Economies
This book tackles important issues that have received far less attention than they
deserve—what drives inflation in emerging and developing economies, what
effects it has on the populations of these economies, and how the scourge of
high inflation can be conquered. The book is rich in data, analysis, and useful
policy prescriptions, all of which are woven together in a masterful and
thoughtful way that makes the book a very useful reference source for academics
and policy makers alike.
Eswar Prasad
Tolani Senior Professor of Trade Policy
Cornell University
This is a truly monumental work, incorporating pathbreaking data collection, a

comprehensive survey of the literature, all viewed through the lens of new
empirical methods. The volume represents a much-needed compilation of the
research on inflation dynamics and broader economic effects, with special
reference to emerging market and low-income country experiences that have
heretofore been largely neglected. This will be the reference on the phenomenon
of inflation for years to come.
Menzie Chinn
Professor of Public Affairs and Economics
University of Wisconsin at Madison
Inflation in Emerging
and Developing Economies
Editors
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ISBN (paper): 978-1-4648-1375-7

ISBN (electronic): 978-1-4648-1376-4
DOI: 10.1596/978-1-4648-1375-7
Cover design: Lauren Kaley Johnson, World Bank Group.
Library of Congress Cataloging-in-Publication Data has been requested.

Summary of Contents
Acknowledgments...................................................................................................... xvii
Abbreviations .............................................................................................................. xix
Chapter Authors ......................................................................................................... xxi
Introduction ............................................................................................................... i.3

PART A Inflation: Global and Domestic Drivers
1 Inflation: Concepts, Evolution, and Correlates...................................................... 5

Jongrim Ha, Anna Ivanova, Franziska Ohnsorge, and Filiz Unsal
2 Understanding Global Inflation Synchronization................................................ 93
Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge, and Filiz Unsal
3 Sources of Inflation: Global and Domestic Drivers ........................................... 143
Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge, and Hakan Yilmazkuday
PART B Inflation: Expectations and Pass-Through
4 Inflation Expectations: Review and Evidence .................................................... 205

M. Ayhan Kose, Hideaki Matsuoka, Ugo Panizza, and Dana Vorisek
5 Inflation and Exchange Rate Pass-Through ....................................................... 271
Jongrim Ha, Marc Stocker, and Hakan Yilmazkuday
PART C Inflation: Low-Income Country Considerations
6 Inflation in Low-Income Countries................................................................... 323

Jongrim Ha, Anna Ivanova, Peter Montiel, and Peter Pedroni
7 Poverty Impact of Food Price Shocks and Policies ............................................ 371
David Laborde, Csilla Lakatos, and Will Martin
Appendix: Cross-Country Database of Inflation and Country Characteristics ........ 403
Index ....................................................................................................................... 425
V
Table of Contents
Acknowledgments..................................................................................................... xvii
Abbreviations ............................................................................................................. xix
Chapter Authors ........................................................................................................ xxi
Introduction: Inflation in Emerging and Developing Economies: Evolution,
Drivers, and Policies ................................................................................................... i.3
Motivation ........................................................................................................... i.3
Key findings and policy messages ......................................................................... i.5
Synopsis ............................................................................................................. i.10
Future research directions................................................................................... i.31
References .......................................................................................................... i.33
PART A Inflation: Global and Domestic Drivers ....................................................... 3

Chapter 1 Inflation: Concepts, Evolution, and Correlates ............................................ 5
Introduction .......................................................................................................... 5
Conceptual considerations ................................................................................... 15
Inflation and economic activity ............................................................................ 17
Evolution of global inflation................................................................................. 19
Long-term correlates of inflation .......................................................................... 35
Conclusion .......................................................................................................... 52
Box 1.1 Benefits and costs of inflation: A review..................................................... 8
Box 1.2 Inflation in low-income countries............................................................ 22
Annex 1.1 Effects of inflation on inequality and poverty....................................... 55
Annex 1.2 Low-income countries ......................................................................... 64
Annex 1.3 Regression analysis .............................................................................. 65
Annex 1.4 Lessons from U.S. disinflation in 1979-82........................................... 68
References ............................................................................................................ 72
VII
Chapter 2 Understanding Global Inflation Synchronization ...................................... 93
Introduction ......................................................................................................... 93
Evolution of inflation synchronization ................................................................ 101
Synchronization across different measures of inflation ......................................... 107
Sources of inflation synchronization .................................................................... 116
Conclusion ......................................................................................................... 123
Box 2.1 Global inflation synchronization: A review............................................... 95
Box 2.2 Global synchronization of inflation and output growth .......................... 108
Annex 2.1 Methodology and database................................................................. 125
References .......................................................................................................... 138
Chapter 3 Sources of Inflation: Global and Domestic Drivers .................................. 143

Introduction ....................................................................................................... 143
Evolution of global and domestic inflation.......................................................... 147
Drivers of global inflation ................................................................................... 150
Drivers of domestic inflation .............................................................................. 158
Conclusion ......................................................................................................... 173
Annex 3.1 Literature review: Drivers of domestic inflation .................................. 175
Annex 3.2 Event studies ..................................................................................... 185
Annex 3.3 Methodology and database................................................................. 186
References .......................................................................................................... 193
PART B Inflation: Expectations and Pass-Through .................................................203

Chapter 4 Inflation Expectations: Review and Evidence............................................205
Introduction ....................................................................................................... 205

Measuring inflation expectations......................................................................... 207
Literature on inflation expectations..................................................................... 212
Inflation expectations: Trends and anchors ......................................................... 218
Determinants of anchoring expectations ............................................................. 221
VIII
Anchoring expectations: Country experiences ..................................................... 227
Conclusion ........................................................................................................ 230
Annex 4.1 Primer on expectations and monetary policy ...................................... 232
Annex 4.2 Studies on the anchoring of inflation expectations ............................. 235
Annex 4.3. Methodology and database ............................................................... 241
Annex 4.4 Estimation results .............................................................................. 246
Annex 4.5 Inflation targeting: Country experiences ............................................ 250
References .......................................................................................................... 262
Chapter 5 Inflation and Exchange Rate Pass-Through ............................................. 271

Introduction....................................................................................................... 271
Exchange rate movements and inflation.............................................................. 279
Pass-through to inflation and underlying shocks ................................................. 284
Pass-through to inflation and structural factors .................................................. 296
Conclusion......................................................................................................... 300
Box 5.1 Exchange rate pass-through: A review .................................................... 273
Annex 5.1 Methodology and database ................................................................ 303
References .......................................................................................................... 310
PART C Inflation: Low-Income Country Considerations ........................................ 321

Chapter 6 Inflation in Low-Income Countries.......................................................... 323
Introduction....................................................................................................... 323
Evolution of inflation in LICs ............................................................................ 326
Transmission of shocks into core price inflation.................................................. 329
Country characteristics and the roles of shocks.................................................... 335
Conclusion......................................................................................................... 348
Annex 6.1 Monetary policy challenges in low-income countries ......................... 352
Annex 6.2 Methodology and database ................................................................ 363
References .......................................................................................................... 368
IX
Chapter 7 Poverty Impacts of Food Price Shocks and Policies.. ............................. 371
Introduction .......................................................................................................371
Food price shocks ..............................................................................................374
Government interventions .................................................................................379
Impact of the 2010-11 food price shock on poverty ........................................... 385
Conclusion .........................................................................................................391
Annex 7.1 Methodology and database .................................................................394
References...........................................................................................................399
Appendix: Cross-Country Database of Inflation and Country Characteristics.......... 403

Measures of inflation...........................................................................................403
Measures of country characteristics......................................................................406
References...........................................................................................................423
Index ........................................................................................................................ 425

Figures
Figure 1 Evolution of inflation ............................................................................. i.4
Figure 2 Inflation and country characteristics ..................................................... i.13
Figure 3 Global inflation synchronization .......................................................... i.15
Figure 4 Drivers of inflation ............................................................................... i.18
Figure 5 Inflation expectations ........................................................................... i.22
Figure 6 Inflation and exchange rate pass-through .............................................. i.25
Figure 7 Drivers of core inflation in low-income countries ................................. i.28
Figure 8 Poverty impact of food price shocks ..................................................... i.30
Figure 1.1 Global inflation..................................................................................... 6
Figure 1.2 Correlation between inflation measures ............................................... 18
Figure 1.3 Inflation and economic activity in EMDEs.......................................... 19
Figure 1.4 Global inflation trends ........................................................................ 21
Figure 1.2.1 Inflation in low-income countries ..................................................... 23
Figure 1.2.2 Factors supporting falling inflation in LICs ...................................... 26
X
Figure 1.5 Inflation in Latin America and Europe and Central Asia .............................29
Figure 1.6 Distribution of inflation ..............................................................................30
Figure 1.7 Components of inflation .............................................................................31
Figure 1.8 Global inflation volatility.............................................................................33
Figure 1.9 Global inflation expectations .......................................................................34
Figure 1.10 Historical perspective.................................................................................36
Figure 1.11 Trade integration and inflation ..................................................................39
Figure 1.12 Capital account openness and inflation ......................................................41
Figure 1.13 Inflation targeting regime and inflation......................................................45
Figure 1.14 Monetary framework, exchange rate regime, and inflation .........................46
Figure 1.15 Central bank transparency and inflation ....................................................48
Figure 1.16 Government debt and inflation..................................................................49
Figure 1.17 Labor markets and inflation .......................................................................51
Figure A.1.1.1 Composition of household income, wealth, and consumption ...............57
Figure A.1.1.2 Inflation, inequality, and poverty ..........................................................61
Figure A.1.4.1 Macroeconomic developments during 1979-82 .....................................69
Figure 2.1.1 Contribution of the global factor to inflation: Literature ...........................96
Figure 2.1 Global and group inflation factors ............................................................103
Figure 2.2 Contributions of global and group factors to inflation ...............................104
Figure 2.2.1 Synchronization in output growth and inflation ....................................110
Figure 2.2.2 Global inflation and output growth factors ............................................112
Figure 2.3 Global inflation factors: Various inflation measures ...................................113
Figure 2.4 Contribution of global and group factors to inflation over time:
Various inflation measures .........................................................................................116
Figure 2.5 Global and group inflation factors: Tradables and nontradables .................117
Figure 2.6 Contribution of the global factor to inflation: EMDEs ..............................122
Figure 3.1 Global and domestic inflation....................................................................144
Figure 3.2 Countries with disinflation and deflation ...................................................145
XI
Figure 3.3 Global inflation around global recessions and oil price plunges ................. 149
Figure 3.4 Global inflation around global business cycle peaks and oil price spikes..... 150
Figure 3.5 Global inflation and global output growth ................................................ 152
Figure 3.6 Global demand, supply, and oil price shocks ............................................ 154
Figure 3.7 Impact of global shocks on global inflation ............................................... 156
Figure 3.8 Impact of global shocks on global inflation over time................................ 157
Figure 3.9 Impact of global shocks on global inflation: Various inflation measures .... 159
Figure 3.10 Impact of global shocks on domestic inflation......................................... 162
Figure 3.11 Contributions of global shocks to domestic inflation............................... 165
Figure 3.12 Correlates of domestic shocks ................................................................. 166
Figure 3.13 Impact of domestic shocks on domestic inflation .................................... 168
Figure 3.14 Evolution of the impact of domestic shocks on inflation ......................... 170
Figure 3.15 Contribution to domestic inflation, by country groups ........................... 172
Figure 4.1 Survey-based measures of inflation expectations: Country evidence ........... 210
Figure 4.2 Survey-based and market-based measures of inflation expectations:
Country evidence ...................................................................................................... 212
Figure 4.3 Long-term inflation expectations .............................................................. 220
Figure 4.4 Sensitivity of inflation expectations to inflation shocks.............................. 222
Figure 4.5 Sensitivity of inflation expectations to global and domestic inflation
shocks........................................................................................................................ 223
Figure 4.6 Determinants of the sensitivity of inflation expectations to shocks ............ 225
Figure 4.7 Time-varying sensitivity of inflation expectations to shocks: Country
experiences ................................................................................................................ 229
Figure A.4.5.1 Inflation targeting in Brazil ................................................................ 252
Figure A.4.5.2 Inflation targeting in Chile................................................................. 256
Figure A.4.5.3 Inflation targeting in Poland .............................................................. 260
Figure 5.1.1 Pass-through following different types of shocks .................................... 276
Figure 5.1 Pass-through during significant currency depreciations ............................ 281
Figure 5.2 Pass-through during significant currency appreciations ............................. 282
XII
Figure 5.3 Correlations between inflation and nominal effective exchange rate
changes ...................................................................................................................... 283
Figure 5.4 Exchange rate responses to domestic shocks............................................... 288
Figure 5.5 Exchange rate responses to global shocks .................................................. 289
Figure 5.6 Variance decompositions of exchange rate movements............................... 290
Figure 5.7 Pass-through associated with domestic shocks............................................ 292
Figure 5.8 Pass-through associated with global shocks ................................................ 293
Figure 5.9 Pass-through associated with exchange rate shocks..................................... 294
Figure 5.10 Average pass-through ............................................................................. 295
Figure 5.11 Central bank credibility and pass-through ............................................... 298
Figure 5.12 Global value chain participation and pass-through .................................. 299
Figure 5.13 Foreign-currency import invoicing and pass-through .............................. 300
Figure A.5.1.1 Pass-through: One versus two-quarter sign restrictions ....................... 306
Figure A.5.1.2 Pass-through: Additional sign restriction to identify domestic
demand shocks .......................................................................................................... 307
Figure 6.1 Inflation levels and volatility, by country group ......................................... 328
Figure 6.2 Median core inflation, by country characteristics ....................................... 330
Figure 6.3 Response of core inflation to global price shocks........................................ 333
Figure 6.4 Response of core inflation to shocks to food prices and exchange rates ....... 335
Figure 6.5 Response of core inflation to global core price shocks ................................ 337
Figure 6.6 Contribution of inflation shocks to core inflation variation ....................... 338
Figure 7.1 Global food prices .................................................................................... 373
Figure 7.2 Macroeconomic channels of transmission ................................................. 376
Figure 7.3 Microeconomic channels of transmission ................................................. 378
Figure 7.4 Food-related government policies.............................................................. 381
Figure 7.5 Domestic and global food prices................................................................ 382
Figure 7.6 Government interventions during 2010-11 .............................................. 389
Figure 7.7 Poverty impact of policies implemented during 2010-11........................... 390
XIII
Tables
Table A.1.3.1 Correlates of change in CPI inflation: Full sample............................. 66
Table A.1.3.2 Correlates of change in CPI inflation: EMDEs .................................. 67
Table 2.1 Variance decompositions: Headline CPI, 1970-2017..............................104
Table 2.2 Variance decompositions, over time: Headline CPI ................................106
Table 2.3 Variance decompositions: Various inflation measures .............................115
Table 2.4 Variance decompositions: Tradables and nontradables ............................118
Table A.2.1.1 Factor models for inflation synchronization in the literature .............127
Table A.2.1.2 List of countries ...............................................................................130
Table A.2.1.3 Variance decompositions over time: Various inflation measures........131
Table A.2.1.4 Correlates of the variance share of the global inflation factor.............136
Table A.2.1.5 Correlates of the variance share of the group inflation factor.............137
Table A.3.1.1 Literature review: Drivers of inflation ...............................................182
Table A.3.3.1 List of countries and sample periods .................................................191
Table A.3.3.2 Contribution of domestic shocks to domestic inflation .....................192
Table A.4.2.1 Studies on advanced economies........................................................235
Table A.4.2.2 Studies on EMDEs ..........................................................................238
Table A.4.3.1 List of countries ...............................................................................244
Table A.4.3.2 Description of the variables ..............................................................245
Table A.4.4.1 Sensitivity of long-term inflation expectations to inflation shocks ....246
Table A.4.4.2 Panel unit root tests .........................................................................247
Table A.4.4.3 Panel cointegration tests ..................................................................248
Table A.4.4.4 Determinants of sensitivity of inflation expectations .........................249
Table A.5.1.1 List of countries and sample periods .................................................309
Table 6.1 Regression of the response of core inflation ............................................342
Table 6.2 Regression of variance decompositions of core inflation .........................343
XIV
Table 6.3 LICs: Regression of the response of core inflation on country
characteristics............................................................................................................. 345
Table 6.4 LICs: Regression of the variance decompositions of core inflation on country
characteristics............................................................................................................. 346
Table 6.5 Regression of the variance of core inflation explained by global core price
shocks on country characteristics................................................................................ 349
Table 7.1 Impact of policy responses to the 2010-11 food price increase on the
number of extreme poor ............................................................................................ 393
Table A.1 Number of countries with available inflation data ...................................... 405
Table A.2 Number of countries with estimates of core inflation ................................. 406
Table A.3 Database.................................................................................................... 415
XV
Acknowledgments
Although only three names appear on its cover, it has taken the proverbial village to
produce this book. We are extremely fortunate to have worked with many outstanding
colleagues and are grateful for their generous and insightful contributions. The seven
chapters of this book are the product of dedicated efforts by our tireless co-authors:
Anna Ivanova, David Laborde, Csilla Lakatos, Will Martin, Hideaki Matsuoka, Peter
Montiel, Ugo Panizza, Peter Pedroni, Marc Stocker, Filiz Unsal, Dana Vorisek, and
Hakan Yilmazkuday. We are also thankful to Sergiy Kasyanenko, Atsushi Kawamoto,
Seong Tae Kim, Wee Chian Koh, Peter Nagle, Yohei Okawa, and Naotaka Sugawara
for their contributions to annexes, boxes, and background literature reviews.
We owe a debt of gratitude to colleagues who provided detailed comments, discussed
our findings, and patiently answered our many questions: Carlos Arteta, John Baffes,
John Beghin, Eduardo Borensztein, Sinem Kilic Celik, Menzie Chinn, Matteo
Ciccarelli, Kevin Clinton, Andrew Dabalen, Zsolt Darvas, Jose De Gregorio, Selva
Demiralp, Shantayanan Devarajan, Alistair Dieppe, Erik Feyen, Norbert Fiess, Hans
Genberg, Stefan Gerlach, Graham Hacche, Raju Huidrom, Ergys Islamaj, Andy Jobst,
Alain Kabundi, Gerard Kambou, Gene Kindberg-Hanlon, Patrick Kirby, Stephen
O’Connell, Tatsuyoshi Okimoto, Christopher Otrok, David Papell, Franz Ruch,
Yirbehogre Modeste Some, Christopher Towe, Kozo Ueda, Mark Watson, Collette M.
Wheeler, Lei Sandy Ye, and Kamil Yilmaz. We also would like to thank the
participants of many internal seminars for useful suggestions on the preliminary
chapters, and numerous scholars and central bank officials for conversations on topics
covered here.
We are deeply grateful to Xinyue Wang and Heqing Zhao for shouldering the lion’s
share of the research assistance burden. We are thankful to Cristhian Javier Vera
Avellan, Zhuo Chen, Ishita Dugar, Hao Jiang, Julia Renee Roseman, and Xueliang
Wang for excellent research assistance.
We are indebted to our colleagues who worked on the production process. Graeme
Littler produced the online publication. Mark Felsenthal, Patricia Katayama, Jewel
McFadden, Koichi Omori, and Tomoko Hirai managed media relations and
dissemination. Mark Felsenthal and Graeme Littler provided editorial support, with
contributions from Betty Dow, Adriana Maximiliano, and Quinn Sutton. Naotaka
Sugawara and Maria Hazel Macadangdang produced the index. Lauren Kaley Johnson
designed the cover. We truly appreciate the herculean efforts of Adriana Maximiliano,
Quinn Sutton, and Maria Hazel Macadangdang in assembling the print publication.
The production of this book was managed by the Prospects Group of the
Development Economics Vice Presidency of the World Bank Group. The Prospects
Group gratefully acknowledges financial support from the Policy and Human
Resources Development (PHRD) Fund provided by the Government of Japan.
XVII
Abbreviations
A annual data
AE advanced economy
ADF augmented Dickey-Fuller unit-root test
AIC Akaike information criterion
AREAER Annual Report on Exchange Arrangements and Exchange Restrictions
BCB Central Bank of Brazil
BCC Central Bank of Chile
BVAR Bayesian vector autoregression
CB central bank
CBI central bank independence and transparency index
CEMAC Central African Economic and Monetary Community
CES constant elasticity of substitution
CGE computable general equilibrium model
CMA commodity-importing EMDEs
CORE core consumer price index
CPI consumer price index
CXA commodity-exporting EMDEs
DD domestic demand
DEF gross domestic product deflator
DOLS dynamic ordinary least squares
DS domestic supply
DSGE dynamic stochastic general equilibrium model
EAP East Asia and Pacific
ECA Europe and Central Asia
ECB European Central Bank
ECM error correction model
ECCU Eastern Caribbean Currency Union
EMDEs emerging market and developing economies
ER exchange rate
ERPTR exchange rate pass-through ratio
EX exchange rate
FAO Food and Agriculture Organization
FAVAR factor-augmented vector autoregression model
FE fixed effects
FIRE full-information rational expectations
FMOLS fully modified ordinary least squares
G7 Group of Seven
GDP gross domestic product
GNI gross national income
GTAP Global Trade Analysis Project
GVAR global vector autoregression
GVC global value chains
IFAD International Fund for Agricultural Development
IFPRI International Food Policy Research Institute
IFS International Financial Statistics
IMF International Monetary Fund
IMP import prices
IRF impulse response function
IT inflation targeting
XIX
LAC Latin America and the Caribbean
LICs low-income countries
MNA Middle East and North Africa
MP monetary policy
MPC Monetary Policy Council
mt metric ton
NBP National Bank of Poland
NEER nominal effective exchange rate
OECD Organisation for Economic Co-operation and Development
OLS ordinary least squares
OPEC Organization of the Petroleum Exporting Countries
PIM Policies, Institutions, and Markets
PP Phillips-Perron unit-root test
PPI producer price index
RHS right-hand side
Q quarterly data
SAR South Asia
SDGs Sustainable Development Goals
SIC Schwarz information criterion
SITC Standard International Trade Classification
SSA Sub-Saharan Africa
SVAR structural vector autoregression model
TiVA Trade in Value Added
UNCTAD United Nations Conference on Trade and Development
VAR vector autoregression
VECM vector error correction model
WAEMU West African Economic and Monetary Union
WFP World Food Programme
WHO World Health Organization
WITS World Integrated Trade Solution
WPI wholesale price index
WTI West Texas Intermediate
WTO World Trade Organization
XR exchange rate
XX
Chapter Authors
Jongrim Ha, Economist, Development Prospects Group, World Bank
Anna Ivanova, Deputy Division Chief, Western Hemisphere Department,

M. Ayhan Kose, Director, Development Prospects Group, World Bank
David Laborde, Senior Research Fellow, International Food Policy Research

Institute
Csilla Lakatos, Senior Economist, Development Prospects Group, World Bank
Will Martin, Senior Research Fellow, International Food Policy Research Institute
Hideaki Matsuoka, Economist, Development Prospects Group, World Bank
Peter J. Montiel, Professor of Economics, Williams College
Franziska Ohnsorge, Manager, Development Prospects Group, World Bank
Ugo Panizza, Professor of Economics, Graduate Institute of International and

Development Studies
Peter Pedroni, Professor of Economics, Williams College
Marc Stocker, Senior Economist, Development Prospects Group, World Bank
Filiz D. Unsal, Economist, Research Department, International Monetary Fund
Dana Vorisek, Senior Economist, Development Prospects Group, World Bank
Hakan Yilmazkuday, Associate Professor of Economics, Florida International

University
XXI
In the 1970s inflation became a severe problem of global dimensions.
Following remarkable stability in the 1960s, prices rose sharply in
1973 and 1974.... The inflationary surge helped provoke the global
recession of 1974-75.… The developing countries did not pass
through these economic disruptions unscathed. Global inflation swept
them along, even regions with traditions of price stability experienced
high domestic inflation rates.
Bruce K. MacLaury (1981)
There are forces in the global economy today that are conspiring to
hold inflation down. Those forces might cause inflation to return
more slowly to our objective. But there is no reason why they should
lead to a permanently lower inflation rate.
Mario Draghi (2016)

INTRODUCTION
Inflation in Emerging and Developing Economies:
Motivation
The global economy has witnessed a remarkable decline in inflation over the
past four to five decades. Inflation has fallen around the world, with median
annual national consumer price inflation down from a peak of nearly 17 percent
in 1974 to about 1.7 percent in 2015—the lowest level in almost half a century
(Figure 1). Among advanced economies, median inflation has similarly dropped
to its lowest level—0.3 percent—from its highest—15 percent—over the same
period.
Encouragingly, emerging market and developing economies (EMDEs) have also
experienced an extraordinary decline in inflation over the same time frame: after
peaking in 1974 at 17.3 percent, inflation in these economies declined to 3.5
percent in 2017—only marginally up from its lowest level in the period, 2.7
percent, reached in 2015. Despite a checkered history of managing inflation
among many EMDEs, disinflation occurred across all regions, including those
with a history of persistently high inflation, such as Latin America and Sub-
Saharan Africa. Even among low-income countries (LICs), inflation has fallen
by two-thirds since the mid-1970s, to 5 percent in 2017.
Although the “near-universal” character of the decline in inflation since the mid-
1970s was recognized at an early stage by Rogoff (2003), research has almost
exclusively focused on low inflation in advanced economies. Many studies have
analyzed the sources of low inflation, its highly synchronized nature, and its
policy implications for these economies. To date, however, no comprehensive
study has explored the evolving dynamics of inflation in EMDEs. This book fills
that critical gap with the following contributions:
• A comprehensive analysis of inflation in EMDEs and LICs. Seven chapters
analyze the recent history of inflation among EMDEs, including its
evolution, its synchronization across countries, the global and domestic
sources of inflation, and the roles of expectations and exchange rate pass-
through. In addition, the book presents a detailed examination of inflation
and monetary policy–related challenges in LICs and assesses their
implications for development outcomes.
• A truly global data set. By assembling a database that includes the largest
sample of countries of any major inflation study, this research is enriched by
information that is considerably more representative of “global inflation”
Note: This chapter was prepared by Jongrim Ha, M. Ayhan Kose, and Franziska Ohnsorge.
i.4 INTRODUCTION I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
FIGURE 1 Evolution of inflation

Global inflation declined from a peak of nearly 17 percent (annual average) in 1974 to 2.6
percent in 2017. The decline was broad-based, across country groups and inflation
measures, but began somewhat earlier in advanced economies than in EMDEs and LICs.
The recent low and stable global inflation environment resembles those of the Bretton
Woods fixed exchange rate system in the post-war period up to the early 1970s, and the
gold standard of the early 1900s.
A. Global core and headline CPI inflation B. Global PPI, CPI, and GDP deflator inflation
C. Inflation in advanced economies and D. Inflation distribution in EMDEs

EMDEs
E. Inflation in LICs F. Inflation and inflation volatility
Source: Haver Analytics; ILOSTAT; International Monetary Fund International Financial Statistics and World Economic
Outlook databases; OECDstat; UNdata; World Bank.
Note: CPI = consumer price index; EMDEs = emerging market and developing economies; GDP = gross domestic product;
LICs = low-income countries; PPI = producer price index.
A. Median headline and core year-on-year inflation for 41 economies, including 16 EMDEs (see details in the Appendix).
B. Median PPI, CPI, and GDP deflator year-on-year inflation for 39 economies, including 22 EMDEs.
C. Median year-on-year consumer price inflation for 29 advanced economies and 123 EMDEs (including 28 LICs).
D. Sample includes 27 advanced economies and 50 EMDEs. Refers to year-on-year inflation.
E. The solid line shows median year-on-year headline inflation; dashed lines refer to the interquartile range, based
on 28 LICs.
F. Median of annual average inflation in 24 countries where data are available across the full period. A = gold standard and
stability (1880-1913); B = World War I and high inflation (1914-18); C = post–World War I depression and deflation
(1920-22); D = Great Depression (1929-33); E = World War II, monetary controls and post-war inflation (1945-49);
E to F = Bretton Woods system of fixed exchange rates (1944-71); F = floating exchange rates and oil shocks
(Organization of the Petroleum Exporting Countries, 1971-79); G = introduction of inflation targeting (1990-2000);
H = global financial crisis.
Click here to download data and charts.
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S INTRODUCTION i.5
than earlier work, which relied predominantly on advanced economy data.

The database further covers multiple measures of inflation and
macroeconomic and structural country features over almost five decades.
• Use of cutting-edge methodologies. The study examines EMDE inflation

using cutting-edge empirical methodologies that have thus far mostly been
employed in studies of inflation in advanced economies. A variety of time-
series and panel econometric models are complemented by event studies,
case studies, and historical comparisons that shed additional light on the
topics under consideration.
Why does inflation matter?
High inflation is often associated with lower growth and financial crises (IMF
2001; Mishkin 2008). Rising price levels are further linked to weaker investor
confidence, undercut incentives to save, and erode financial and public sector
balance sheets. Moreover, the damage of high inflation can fall
disproportionately on the poor, since poorer households are more reliant on
wage income, have less access to interest-bearing accounts, and are unlikely to
have significant holdings of financial or real assets apart from cash. For these
reasons, low and stable inflation has been associated with better growth and
development outcomes, financial stability, and poverty reduction.1
Key findings and policy messages

The book offers a range of analytical findings and policy messages. A recurring
theme is the benefits of stability-oriented and resilient monetary policy
frameworks, including central bank transparency and independence. Such policy
frameworks need to be complemented by strong macroeconomic and
institutional arrangements. For many EMDEs, measures to strengthen monetary
policy frameworks, and macroeconomic policy frameworks more broadly, are
particularly urgent. The book documents that inflation expectations are more
weakly anchored in EMDEs than in advanced economies and, in EMDEs that
do not operate inflation targeting frameworks, exchange rate movements tend to
have larger and more persistent effects on inflation.
1 Extremely low inflation, however, such as has prevailed in many advanced economies over the past
decade, can also be problematic: it may make it difficult for central banks to lower real short-term interest
rates sufficiently to provide the requisite stimulus to demand, given the lower bound on nominal interest
rates; and it may tip into deflation—a sustained decline in prices—which can exacerbate recessionary
tendencies (Blanchard, Dell’Ariccia, and Mauro 2010; Arteta et al. 2018).
Low inflation: Here to stay?

Disinflation over recent decades has been broad-based across country groups and
is evident in multiple measures of inflation, including headline and core
consumer prices, energy and food prices, producer prices, and the gross domestic
product (GDP) deflator.2 Disinflation began in advanced economies in the mid-
1980s and in EMDEs in the mid-1990s. By 2000, global inflation had stabilized
at historically low levels. Inflation in EMDEs fell from stubbornly persistent
double digits during the 1970s, 1980s, and most of the 1990s to 3.5 percent in
2017. By 2017, inflation was within or below central bank target ranges in
three-quarters of EMDEs that had adopted inflation targeting. As the level of
inflation has fallen, its volatility has also declined, most sharply in the transition
economies of the former Soviet Union and in Sub-Saharan Africa.
Is low inflation here to stay? A reason for optimism is that the confluence of
structural and policy-related factors that have fostered global disinflation is
unlikely to be reversed. Foremost among these has been unprecedented
international trade and financial market integration. In the median EMDE, as
in the median advanced economy, trade has increased by half since 1970, to 75
percent of GDP in 2017, and international assets and liabilities have more than
tripled (although they remain only one-quarter the level of advanced
economies). Technological changes have also transformed production processes
in ways that affect the formation of prices (Draghi 2016; Lowe 2017; Yellen
2017).
On the policy front, the adoption of more resilient monetary, exchange rate, and
fiscal policy frameworks by some EMDEs has facilitated more effective control
of inflation (Hammond, Kanbur, and Prasad 2009; Taylor 2014; Fischer 2015).
Twenty-four EMDEs have introduced inflation targeting monetary policy
frameworks since the late 1990s. In some EMDEs, structural reforms of labor
and product markets have also supported disinflation by making markets more
flexible and strengthening competition.
However, there are reasons to worry that factors that have held inflation at bay
over the past decades may lose momentum or be rolled back. In his seminal
essay, Rogoff (2003) concludes that “the greatest threat to today’s low inflation,
of course, would be a reversal of the modern trend toward enhanced central
bank independence, particularly if trend economic growth were to slow, owing,
say, to a retreat in globalization and economic liberalization.” The rising
protectionist sentiment of recent years and reform fatigue in some economies
may slow the pace of globalization and structural policy improvements.
2 Disinflation is a decline in inflation rates, regardless of inflation being negative (deflation) or positive.
Mounting public and private debt in many countries could weaken commitment
to strong fiscal and monetary frameworks. These reversals, especially if they were
to coincide with tight labor markets or commodity price volatility, could reignite
inflation.
The current period of low and stable inflation resembles those of the Bretton
Woods fixed exchange rate system of the post-war period up to 1971 and the
gold standard of the early 1900s. All three episodes are characterized by inflation
below 5 percent for an extended period. It is notable, however, that the two
earlier episodes were followed by sharply rising inflation, illustrating that
maintaining low inflation can be as great a challenge as achieving low inflation.3
The achievement of low inflation over the course of the past four to five decades
may be by no means permanent (Rogoff 2014; Draghi 2016; Carstens 2018). If
unwanted inflation makes a comeback, many EMDEs would be particularly
vulnerable to the undesirable economic outcomes associated with high inflation:
their inflation expectations are less well anchored, and the absence of strong
monetary policy frameworks in many of these economies means that inflation is
more sensitive to exchange rate movements. In addition, as debt loads have risen
in recent years, EMDE fiscal positions have become increasingly vulnerable to
shifts in market sentiment and rising borrowing costs. Central banks may
struggle to contain inflationary pressures and may not receive much support
from stabilizing fiscal policy.
Global inflation cycle: Learning to live with it

A critical feature of the international inflation experience of the past four to five
decades has been the rising importance of a “global inflation cycle” (captured in
a common global factor) in explaining inflation at the country level (Carney
2015). Since 2001, this global factor has accounted for one-quarter of the
inflation variation in the median advanced economy and almost one-fifth in the
median EMDE. The role of the global inflation cycle has been most prominent
in countries that are more developed and more integrated into the global
economy.
The emergence of a global inflation cycle was likely driven by multiple structural
and cyclical forces, including globalization, technological progress, changes in
3 In the 1970s, inflation became a serious global problem after a remarkable period of price stability in
the 1960s. The sharp increase in oil prices in 1973-74 led to a rapid acceleration in inflation and sharp
decline in growth in many countries. This major oil price shock also triggered the 1975 global recession
that in turn marked the beginning of a prolonged period of stagflation (Kose and Terrones 2015). Global
inflationary pressures also led to a significant increase in domestic inflation in developing economies,
including those that experienced relatively low and stable inflation in the late 1960s and early 1970s
(Cline 1981; Bordo and Orphanides 2013).
policy frameworks, and a variety of cyclical global shocks. For example, global
demand shocks and oil price shocks have each accounted for 40 percent of the
variation in global inflation since 1970. In the median country, three global
shocks—global demand shocks, supply shocks, and oil price shocks—have
accounted for about one-quarter of domestic inflation variation since 2001. Of
these, the most important were global demand (especially the global recession of
2008-09) and oil price shocks (especially the plunge of 2014-16). Nonetheless,
domestic shocks—especially domestic supply shocks—have remained the main
source of domestic inflation variation.
A strengthening global inflation cycle raises concerns that central banks’ control
over domestic inflation may have weakened. Inflation synchronization in and of
itself need not warrant policy intervention (IMF 2018). However, heads of
major advanced economy central banks have acknowledged the need to consider
the global environment in setting monetary policy in light of the highly
synchronized nature of global inflation (Bernanke 2007a; Draghi 2015; Carney
2015). The increased synchronicity of global inflation could increase the risk of
policy errors when the appropriate response to undesirably low or high inflation
differs depending on the origin (domestic versus foreign) of the underlying
inflation shock (Hartmann and McAdam 2018). In addition, a weakening of
monetary policy influence over domestic inflation could raise the stakes for fiscal
policy to respond to excessive or insufficient domestic demand.
For policy makers, these observations suggest an increasing urgency to build

resilience to global and domestic shocks and develop a keener understanding of
their underlying sources. This is particularly the case for EMDEs with deep or
rapidly growing integration into the global economy or ones with weak
monetary policy frameworks. Options to help insulate economies from the
impact of global shocks include the active use of countercyclical policies;
strengthening institutions, including through greater central bank independence;
and establishing a fiscal environment that is resilient enough to contribute
effectively to macroeconomic stabilization.
The global inflation cycle could also strengthen the case for coordinated
monetary policy action to respond to undesirably low or high global inflation.
Coordinated action could amplify the impact of policies implemented by
individual countries.
Anchoring inflation expectations: Better but not enough
Long-term inflation expectations have declined and become more firmly

anchored in the past two decades in both advanced economies and EMDEs.
However, expectations are more weakly anchored in EMDEs in general than in
advanced economies. The introduction of inflation targeting regimes and
increased central bank transparency has been associated with the firmer mooring
of long-term expectations. Among EMDEs, lower public debt ratios and greater
trade openness have also been associated with stronger anchoring of
expectations.
Exchange rate pass-through: Amplification mechanism

Exchange rate pass-through to inflation varies widely among EMDEs,
depending on the sources of shocks and country characteristics. Exchange rate
movements that stem from domestic monetary policy shocks are often
accompanied by above-average pass-throughs to inflation in EMDEs. The
impact on inflation of exchange rate movements resulting from domestic
demand shocks typically produces negative or insignificant pass-through ratios,
reflecting the offsetting effects of the growth and exchange rate channels. Global
shocks account for a relatively smaller proportion of exchange rate movements,
and their pass-through depends on country characteristics and the source of the
shock. Greater central bank independence and the adoption of credible inflation
targets are associated with significantly lower average pass-throughs.
These findings underscore the importance of understanding the underlying

sources of exchange rate movements in the formulation of appropriate monetary
policy responses. Moreover, a credible commitment to maintaining low and
stable inflation can play a key role in dampening the pass-through of even
sizable currency depreciations to prices in EMDEs.
Inflation in LICs: Challenges abound

Global factors have been an important driver of the decline in LIC inflation
since 1990. What sets LICs apart from other country groups may be not so
much that they differ in country characteristics, but that these characteristics
appear to operate differently in the LIC environment. For example, although
LICs with fixed exchange rates seem to succeed in anchoring inflation
expectations about as well as other EMDEs with fixed rates, LICs with floating
exchange rates have had a much more difficult time anchoring inflation
expectations than other countries with floating rates. In part because of poorly
anchored inflation expectations, any temporary shocks to inflation, such as those
arising from food price spikes, can trigger higher inflation than LIC central
banks can contain. Separately, the transmission of global food price spikes to
domestic LIC inflation (combined with unintended consequences of other
policies) can materially raise poverty, as observed during the global food price
spikes in 2007-08 and 2010-11.
The sizable role that global factors have played in driving inflation in LICs
points to the need to improve LIC central bank control over domestic inflation.
For example, central banks could strengthen their efforts to convince the public
of the primacy of the low-inflation objective by committing to an inflation
target. However, this strategy may not yet be appropriate for LICs, many of
which have weak and uncertain channels of monetary policy transmission, data
deficiencies, and limited analytical capacity at their central banks. Beyond
monetary policy, the judicious use of budgetary levers that are consistent with
macroeconomic stability is critical for LICs. In addition, LICs need to undertake
structural reforms that reduce their vulnerability to shocks, strengthen automatic
fiscal stabilizers, improve the effectiveness of discretionary fiscal policy, and
increase the flexibility of labor markets.
A nuanced policy approach is necessary to mitigate the impact of global food

price shocks on poverty without adverse side effects. The use of trade policies
(such as changes in export and import restrictions) to insulate domestic
markets from food price shocks may compound the volatility of
international prices and ultimately be counterproductive in protecting the
most vulnerable people. Instead, storage policies and targeted safety net
interventions, such as cash, food, and in-kind transfers, can mitigate the
negative impact of food price shocks while avoiding the economywide
distortionary impacts of trade policies. Measures such as crop and weather
insurance, warehouse receipt systems, commodity exchanges, and futures
markets could also be used to manage risks.
Synopsis
The remainder of this introduction presents a summary of each chapter. After
presenting the motivation of the chapter, each summary explains the main
questions, contributions to the literature, and analytical findings. After the
summaries, a brief discussion of future research directions is presented.
Part A. Global and Domestic Drivers

Part A first analyzes the evolution of inflation and its correlates and
consequences. It then turns to the extent of global inflation synchronization and
the roles of global and group-specific factors in driving inflation in EMDEs. It
concludes with an analysis of the global and domestic sources of inflation in
these economies.
Chapter 1. Inflation: Concepts, Evolution, and Correlates
In Chapter 1, Ha, Ivanova, Ohnsorge, and Unsal analyze the impact of inflation
on activity, provide a comprehensive analysis of the evolution of inflation over
time, and document the main factors that have contributed to disinflation in
recent decades across the world. They address the following questions:
• How does inflation support or hinder economic activity?

• How has global inflation evolved over the past four to five decades?
• What factors have contributed to these trends in global inflation?

The chapter’s contributions to the literature are threefold. First, it documents
the broad-based nature of disinflation over almost half a century using a sample
of countries that is much larger than that of earlier studies, and so provides a
truly global picture. Second, in contrast to earlier studies, the chapter identifies
stylized facts that are robust across different measures of inflation and extend to
various groups of countries. Third, it provides a systematic analysis of the
structural factors that have been credited with helping to lower inflation over the
past four to five decades, including increased global economic integration and
strengthened macroeconomic policy frameworks.
Before delving into the evolution of inflation and its determinants, the authors
review the literature on the impact of inflation on activity, poverty, and
inequality. Previous studies show that low and stable inflation has often been
associated with more stable output and employment and more rapid output
growth and investment (Khan and Senhadji 2001; Woodford 2003; Mishkin
2008). Although the evidence regarding the effect of inflation on poverty is
mixed when assessed at the economywide level, the negative effects of inflation
are more established when examined at the household level.
The empirical exercise conducted in the chapter leads to three major findings.
First, inflation has fallen around the world, reaching historically low levels by
2000 (Figure 1). The decline has been evident among advanced economies and
EMDEs, although it began earlier in advanced economies (in the mid-1980s)
and started in EMDEs in the mid-1990s. Lower inflation was also accompanied
by lower inflation volatility, especially in advanced economies.
Second, this global disinflation has been supported by a wide range of structural
changes. The most significant of these have been globalization—increased
international economic integration—and the adoption of more effective and
more resilient monetary, exchange rate, and fiscal policy frameworks (Figure 2).4
Third, although it features lower inflation volatility, the current period of low
and stable inflation is similar to two historical episodes: the Bretton Woods fixed
4 Rogoff (2003) anticipates the discussion here, with an overview of the main factors supporting lower
inflation, including globalization and broad-based changes in monetary policy regimes. Cecchetti and
Krause (2002) document that lower average inflation has been associated with greater central bank
credibility and, to a lesser extent, transparency in 24 advanced economies. Shambaugh (2004) examines
the role of the external environment in monetary policy for different types of exchange rate regimes.
exchange rate system of the post-war period up to 1971 and the gold standard of
the early 1900s. These two earlier episodes were followed by sharply rising
inflation as soon as the two fixed exchange rate regimes were abandoned (Cline
1981; Bordo 1999).
After documenting inflation trends over almost half a century, Chapters 2 and 3
turn to the global synchronization of inflation and underlying drivers of
inflation movements.
Chapter 2. Understanding Global Inflation Synchronization
In Chapter 2, Ha, Kose, Ohnsorge, and Unsal motivate their study with a well-
known observation: inflation has recently appeared to move in tandem among
countries around the globe. They then explore the extent to which global and
group-specific factors have driven national inflation rates that led to highly
synchronized movements in inflation. In this context, they ask three questions:
• How has inflation synchronization among countries around the world

evolved over the past four to five decades?
• Which goods and price indexes have been associated with greater inflation
synchronization?
• What country characteristics have been associated with greater inflation

synchronization?
The chapter makes several contributions to the rapidly growing literature on

global inflation. First, the authors employ one of the largest samples of countries
among existing studies—a sample that is considerably more representative of
“global inflation” than those used in most earlier studies that relied
predominantly on data from advanced economies.5 In their global sample, the
evidence of growing global inflation synchronization during the 2000s is
unambiguous, whereas some earlier studies based on advanced economy samples
have found no such increase. Second, the authors employ a dynamic factor
model to examine the extent of inflation synchronization around the world. In
recognition of structural differences between EMDEs and advanced economies,
their model explicitly allows for distinct roles for an EMDE factor and an
advanced economy factor, whereas the focus of the literature thus far has been
on global factors only. Third, the chapter systematically explores commonalities
5 Ciccarelli and Mojon (2010), Neely and Rapach (2011), Mumtaz and Surico (2012), and Auer,
Levchenko, and Sauré (2017) examine the extent of global inflation synchronization and its drivers.
FIGURE 2 Inflation and country characteristics

Greater trade and financial account openness, deeper supply chain integration, and
greater central bank independence and transparency have been associated with lower
and more stable inflation.
A. Inflation, by trade openness B. Inflation, by capital account openness
C. Countries with improving central bank D. Inflation, by central bank independence

independence and transparency (1998-2014) and transparency
Source: Chinn and Ito 2006; Dincer and Eichengreen 2014; International Monetary Fund; World Bank.
Note: Inflation volatility is defined as volatility in cyclical inflation, detrended using Stock and Watson’s (2016) methodology.
EMDEs = emerging market and developing economies; GDP = gross domestic product; LICs = low-income countries.
A. Columns indicate median inflation in countries with trade-to-GDP ratios in the top quartile, during 1970-2017. Horizontal
bars indicate countries with trade-to-GDP ratios in the bottom quartile. See the Appendix for detailed descriptions on the
measures of country characteristics. The difference in inflation levels and volatility (except for volatility in advanced
economies) between high and low trade openness is statistically significant at the 1 percent level.
B. Columns indicate median inflation rates and inflation volatility in country-year pairs with the Chinn-Ito index in the top
quartile over 173 economies during 1970-2017. Horizontal bars indicate countries in the bottom quartile. The difference in
inflation levels and volatility between high and low capital account openness is statistically significant at the 1 percent level.
C.D. The central bank independence and transparency index is taken from Dincer and Eichengreen (2014), extrapolated as
described in the Appendix. The index ranges from 0 (least independent and transparent) to 15 (most independent and
transparent). The difference in inflation levels and volatility between high and low central bank independence and
transparency is statistically significant at the 1 percent level.
D. Columns indicate median inflation rates and inflation volatility in country-year pairs with a central bank independence
and transparency index in the top quartile of the sample. Bars denote medians for country-year pairs in the bottom quartile.
and differences in inflation synchronization among a wide range of inflation

measures based on price indexes that differ in their tradables content. This
permits a more precise interpretation of the global factor and broadens the
evidence for increased inflation synchronization. Fourth, the authors
systematically study a wider range of country characteristics that are conducive
to high inflation synchronization than has been examined in earlier studies.
The analysis yields the following main results.
First, inflation has become increasingly globally synchronized (Figure 3). The
role of the global factor has grown, and, since 2001, it explains about one-fifth
and one-quarter of EMDE and advanced economy inflation variation,
respectively. But over the past four decades, an EMDE-specific factor has also
become increasingly important, and since 2001 it has explained nearly a tenth of
EMDE inflation variation. With the rising importance of these global and
group-specific factors, inflation synchronization has also become more broad-
based over time.
Second, international synchronization of inflation has tended to be higher than

that of output growth over the past four to five decades. Differences in the
degree of synchronization in output growth and inflation may reflect differences
in the nature and frequency of global shocks and structural factors, including the
evolution of policy frameworks, that influence these two variables. However, the
degree of synchronization of output growth has increased over time to become
comparable to that of inflation.
Third, global inflation synchronization has broadened—across different types of
goods and countries. In 1970-85, the extent of inflation synchronization was
pronounced only for inflation measures with large portions of tradable goods; it
has more recently become sizable across all inflation measures. During 1970-
2017, it was most pronounced for the inflation measures with the largest share
of tradables. Since 2001, the contribution of a global factor to inflation variation
has grown to one-third even for the core consumer price index (CPI) inflation
and GDP deflator.
Fourth, countries differ widely in the degree to which global factors and, to a
lesser extent, group factors, account for domestic inflation variation. The global
factor has accounted for a larger share of domestic inflation variation in
countries that were more open to global trade, participated more in global value
chains, relied on commodity imports, and were more developed. In general, the
global factor has explained a greater share of inflation variability in EMDEs that
were commodity importing or open to trade. It has also been larger in countries
with more resilient monetary policy frameworks. That said, over the past four to
five decades, this heterogeneity has narrowed such that, since 2001, no country
characteristic appears to account systematically for greater contributions of
global or group factors.
The analysis in Chapter 2 identifies a global inflation cycle and documents the
emergence of group-specific factors in explaining national inflation rates.
However, it does not quantify the fundamental sources of global and national
inflation, and, beyond providing suggestive evidence of a relationship with
FIGURE 3 Global inflation synchronization

Inflation has become increasingly globally synchronized. The global factor accounted for a
higher share of the inflation variance in advanced economies than in EMDEs. A greater
tradable goods and services content of the price basket was associated with a higher
share of the global factor in inflation variance. Inflation synchronization has been stronger
than the synchronization of output growth, especially in EMDEs.
A. Contributions of global and group factors B. Contribution of global factor to inflation

to inflation variation variation, by income group
C. Contribution of global factor to inflation D. Contribution of global and group factors to

variation, over time inflation measures
E. Contribution of global and group factors to F. Contribution of global factor to output

inflation variation growth and inflation variation
Source: World Bank.

Note: CPI = consumer price index; EMDEs = emerging market and developing economies; GDP = gross domestic product;
PPI = producer price index.
A.-C. The results are based on a dynamic factor model with inflation in 99 countries (25 advanced economies and 74
EMDEs). The model includes global and group inflation factors. All numbers refer to median variance shares of total
inflation variance counted by the global or group factors.
D.E. The global and group inflation factors are estimated with a two-factor dynamic factor model for annual inflation in 38
countries (25 advanced economies and 13 EMDEs) for the period 1970-2016, the size of the sample being constrained by
data availability.
E. Median variance share of global factor in inflation variation. The common factor from three measures for domestic
inflation (import prices, producer prices, and headline consumer prices) is used as a proxy variable for the common
component for tradable goods. Similarly, common factors for headline consumer prices, core consumer prices, and the
GDP deflator are extracted as a proxy for the global inflation factor for nontradable goods.
F. Median contribution of the global and group factor to the variance of real GDP growth and to inflation in 99 countries,
based on a two-factor dynamic factor model.
certain country characteristics, the chapter does not interpret these global or
group-specific factors. These issues are taken up in the next chapter.
Chapter 3. Sources of Inflation: Global and Domestic Drivers

Ha, Kose, Ohnsorge, and Yilmazkuday begin their analysis in Chapter 3 with a
summary of the main movements in global inflation over almost half a century:
since 1970, global inflation has undergone considerable swings around a
pronounced downward trend. These swings in inflation have generally been
associated with cyclical fluctuations in the global economy or sharp movements
in oil prices. They then build on the work of Chapter 2 by analyzing the
underlying drivers of global and national inflation. Specifically, they address the
following questions:
• What have been the main drivers of global inflation?
• What have been the main drivers of domestic inflation?
• How have the main drivers of domestic inflation differed by country
characteristics?
The chapter expands the literature in several dimensions. First, it systematically
examines the sources of variation in global inflation in a unified econometric
model that also serves to explain domestic inflation for a more diverse sample of
countries than existing studies.6 Unlike previous studies that have focused on
subsets of the possible drivers of inflation, this chapter examines the
contributions of global shocks (global demand, global supply, and global oil
price shocks) to global inflation movements, and then quantifies the drivers
(domestic demand, supply, monetary policy, and exchange rate shocks) of
domestic inflation while controlling for the influence of global shocks. Second,
in contrast to previous studies, the chapter employs a global sample of countries,
allowing an analysis of inflation dynamics in advanced economies and EMDEs
over a long period. Third, the chapter employs an event study to analyze the
movements in global and domestic inflation rates during major economic events
since 1970. By putting the recent low-inflation episode in historical context, the
chapter highlights the exceptional severity of inflation weakness over the past
decade. Fourth, the chapter investigates a wide range of country characteristics
6 Charnavoki and Dolado (2014), Conti, Neri, and Nobili (2015), and Forbes, Hjoertsoe, and Nenova
(2017, 2018) also analyze the role of different types of factors in explaining domestic inflation, but they
focus on narrower subsets of drivers of inflation in the context of mostly advanced economy samples.
Another branch of the literature relies on more traditional Phillips curve models to quantify the response
of inflation to changes in domestic and global output gaps or cost factors (Borio and Filardo 2007;
Gerlach et al. 2008; Ihrig et al. 2010; Eickmeier and Pijnenburg 2013; Auer, Borio, and Filardo 2017).
However, this literature reports mixed findings about the importance of global drivers of domestic
inflation.
to see which are associated with a particularly high contribution of global (or
domestic) shocks to domestic inflation variability.
The authors report the following findings.
First, rapid changes in global inflation have generally occurred near turning
points of the global business cycle or in the wake of sharp movements in global
oil prices. In particular, following the global financial crisis and subsequent
recession, the past decade witnessed a pronounced and broad-based disinflation
that took global inflation well below its downward trend. Exceptionally large
fractions of advanced economies (more than three-quarters) and EMDEs (more
than one-half) were in outright deflation at some point during 2014-17.
Second, global demand and oil price shocks have accounted for 40 percent,
each, of the variation in global inflation since 1970 (Figure 4). Negative global
demand shocks were associated with three global recessions and slowdowns, but
large positive global demand shocks often coincided with the year before the
global economy slid into a recession or slowdown. Positive oil price shocks were
generally associated with oil supply disruptions, often coinciding with armed
conflict or civil unrest (for example, the Iran-Iraq War, the Iranian Revolution,
and the Persian Gulf War) or militant attacks on pipelines (for example, in Iraq
and Nigeria). Negative oil price shocks were associated with major decisions of
the Organization of the Petroleum Exporting Countries to end production
restraint amid discoveries of new sources of oil supply (1986, 2014-16) or price
normalization after spikes. The relative importance of global demand shocks has
increased since 2001, to account for 60 percent of global inflation variation.
However, the 2014-16 oil price plunge was a major source of post-crisis global
disinflation.
Third, during the past four to five decades, domestic shocks accounted for about
three-quarters of domestic inflation variation, the most important being
domestic supply shocks. Since 2001, however, the role of domestic supply
shocks has declined. During this period, in part as a result of the global financial
crisis and the 2014-16 oil price plunge, the contributions to domestic inflation
variation of global demand and oil price shocks have increased to 22 and 17
percent, respectively.
Finally, the contribution of global shocks to domestic inflation variation was

larger in advanced economies and countries with higher trade and financial
openness, fixed exchange rate regimes, and greater reliance on commodity
imports. Domestic shocks contributed more to domestic inflation variation in
countries that were less open to global trade and finance and had inflation
targeting monetary policy regimes with flexible exchange rates.
FIGURE 4 Drivers of inflation

Global recessions and oil price plunges were typically associated with slowing global
inflation. Reflecting this, the estimation results indicate that, since the 1970s, global
demand and oil price shocks have accounted for a growing share of the variation in global
inflation and domestic inflation. That said, domestic shocks have continued to account for
about three-quarters of domestic inflation variation, with domestic supply shocks being
most important.
A. Global inflation around global recessions B. Global inflation around oil price plunges
C. Contribution of global shocks to global D. Share of countries with statistically

inflation variation over time significant impulse responses after two years
E. Contribution of global shocks to domestic F. Contributions of domestic and global

inflation variation shocks to domestic inflation variation
Source: World Bank.

Note: EMDEs = emerging market and developing economies; GDP = gross domestic product.
A.B. The horizontal axis indicates years before and after the troughs of global recessions or local troughs of short-term oil
price cycles (t=0). Global inflation is defined as median trend inflation (nine-quarter moving average) across 65 countries.
A. Troughs of global recessions are identified using global per capita GDP and the algorithm in Harding and Pagan (2002)
and are consistent with the results in Kose and Terrones (2015).
B. There were six oil price plunges of more than 30 percent (1986, 1990-91, 1997-98, 2001, 2008, and 2014-16) (Baffes et
al. 2015). The four episodes with the largest oil price plunges are presented.
C.-F. The results are based on the country-specific factor-augmented vector autoregression estimation, as discussed in
Chapter 3.
C.E.F. All numbers refer to median shares of variance.
C.E. Share of global inflation variance (C) or domestic inflation variance (E) accounted for by global shocks.
D. Based on cumulative impulse response of domestic inflation to global shocks after two years.
PART B. Expectations and Pass-Through
Part B delves deeper into two key challenges that confront EMDE central banks.
Burdened by a history of high inflation, many EMDE central banks struggle to
build credibility, leaving inflation sensitive to shocks and inflation expectations
unanchored. Additionally, EMDE exchange rates can be subject to severe
swings, amplifying the impact of exchange rate movements on inflation.
Chapter 4. Inflation Expectations: Review and Evidence
In Chapter 4, Kose, Matsuoka, Panizza, and Vorisek argue that, since EMDEs
tend to experience more pronounced business and financial cycles than
advanced economies, they face greater challenges in anchoring expectations.
This makes understanding how inflation expectations are affected by different
types of shocks especially critical for policy makers in these economies.7
Since robust measurement is key to evaluating inflation expectations, they first
examine the pros and cons of survey-based and market-based measures.8 Due to
the breadth of country coverage and the availability of long time series, they
employ survey-based inflation expectations in their empirical work. They then
present a survey of the literature on inflation expectations. Theoretical studies
have examined how public and private information is used by economic agents
in formulating inflation expectations.9 A large body of empirical work has tested
the predictions of theoretical models and assessed how firmly inflation
expectations are anchored, by measuring the sensitivity of expectations to
various shocks. This literature, while extensive, has mainly focused on advanced
economies.
The chapter, therefore, represents the first comprehensive analysis of the
evolution and determinants of inflation expectations in EMDEs. Specifically, it
addresses three key questions:
• How does the degree of anchoring of inflation expectations differ between
advanced economies and EMDEs?
• How sensitive are inflation expectations to global and domestic shocks?
• What are the main determinants of the degree of anchoring of inflation
expectations?
7Bernanke (2007b) explains the importance of inflation expectations for the design of monetary policy.
8For background on market- and survey-based measures of inflation expectations, see Coibion et al.
(2018) and Grothe and Meyler (2018) for the United States and the Euro Area, and Sousa and Yetman
(2016) for EMDEs.
9 Coibion, Gorodnichenko, and Kamdar (forthcoming) and Mankiw and Reis (2018) survey the
literature on the formation of expectations.

The chapter studies these issues by taking novel approaches in several

dimensions. First, it employs data for a large and diverse sample of countries (24
advanced economies and 23 EMDEs) for a period of close to three decades.10
Second, it analyzes the degree of anchoring of inflation expectations by
employing two empirical strategies: a panel regression model and a time-varying
coefficients model. The former approach provides an overview of how well
expectations are anchored in different country groups and time periods; the
latter is useful for tracking how country-specific and time-varying measures of
the degree of anchoring have evolved. Third, the chapter examines the
determinants of the degree of anchoring of expectations, using a dynamic panel
regression framework. Fourth, it complements these empirical exercises with
case studies that examine the role of inflation targeting in stabilizing inflation
expectations in three EMDEs.
This strategy yields the following major results.
First, long-term inflation expectations have declined and become more firmly
anchored in the past two decades in advanced economies and EMDEs (Figure
5). However, anchoring in EMDEs remains notably weaker than in advanced
economies. This finding is consistent with the view that monetary policy
remains less credible in EMDEs than in advanced economies.
Second, long-term inflation expectations in EMDEs are more sensitive to global

and domestic shocks than are expectations in advanced economies. However,
the sensitivity of EMDE inflation expectations to domestic shocks gradually fell
between 2005 and 2012 and has since been mostly stable while their sensitivity
to global shocks has fallen slightly since 2000. This contrasts with the experience
of advanced economies, where a large drop in the sensitivity of inflation
expectations to global shocks in the wake of the global financial crisis followed a
steady decline from the late 1990s to the late 2000s, and there was a less
pronounced downward trend in sensitivity to domestic shocks.
Third, the institutional and monetary policy environment matters for

anchoring inflation expectations, as do the general macroeconomic environment
and structural characteristics of the economy. The authors report that the
presence of an inflation targeting regime and a rise in central bank transparency
are associated with better anchoring of long-term inflation expectations. For
EMDEs, lower public debt ratios and greater trade openness are also associated
with better anchoring of expectations.
10 IMF (2016, 2018) and Mehrotra and Yetman (forthcoming) also study inflation expectations in
advanced economies and EMDEs.

Fourth, case studies of Brazil, Chile, and Poland provide examples of how these
factors have worked to anchor inflation expectations. In Brazil, for instance,
accommodative fiscal policy and backtracking on central bank transparency for a
period may have held back progress on improving the anchoring of inflation
expectations. In Chile, a highly transparent central bank, together with a
credible macroeconomic framework, appear to have contributed to the central
bank’s success in anchoring inflation expectations. And in Poland, the
simultaneous adoption of inflation targeting and exchange rate flexibility seems
to have helped anchor expectations.
Chapter 5 focuses on the role of another channel for monetary policy

transmission that is especially important for EMDEs—the pass-through of
changes in the exchange rate to domestic prices. It takes the novel approach of
quantifying, in a large sample, the extent to which exchange rate pass-through
varies according to the different types of shocks that lead to movements in
exchange rates.
Chapter 5. Inflation and Exchange Rate Pass-Through
Ha, Stocker, and Yilmazkuday motivate their study with a basic observation:
monetary policy authorities in EMDEs have long been worried that significant
exchange rate fluctuations can jeopardize price stability and force disruptive
policy adjustments. As a result, some EMDEs have adopted managed currency
arrangements or employ aggressive policy responses to dampen undesirable
currency movements—practices motivated by what has been dubbed the “fear of
floating” (Calvo and Reinhart 2002). However, the resulting lack of exchange
rate flexibility can amplify the impact of external shocks and make it more
difficult for a central bank to anchor inflation expectations credibly.
Although large depreciations have become less frequent in EMDEs, they

continue to be associated with large increases in inflation. To formulate the
appropriate monetary policy response to exchange rate movements, it is essential
to assess correctly their impact on inflation. But pass-through ratios—the
percentage increase in consumer prices associated with a 1 percent depreciation
of the nominal effective exchange rate—are found to vary considerably across
countries and over time. Two fundamental factors help to account for these
variations: the nature of the shock triggering the currency movement and
country characteristics.
To explore these issues in detail, the authors build on the econometric

framework developed in Chapter 3, but they focus on the relative responses of
inflation and exchange rates to domestic and global shocks. They address three
questions:
FIGURE 5 Inflation expectations

After declining in the 1990s, inflation expectations in advanced economies have remained
stable at around 2 percent since the mid-2000s. Inflation expectations in EMDEs declined
in the second half of the 1990s, but have risen somewhat since 2005, and remain higher
than in advanced economies. The sensitivity of inflation expectations to inflation surprises
has fallen in the past decade in advanced economies and EMDEs but remains
comparatively higher in EMDEs. Inflation expectations in EMDEs are better anchored in the
presence of an inflation targeting regime, and when central bank transparency is high.
A. Inflation expectations, advanced B. Inflation expectations, EMDEs

economies
C. Sensitivity of inflation expectations to D. Sensitivity of inflation expectations to

inflation shocks, advanced economies inflation shocks, EMDEs
E. Impact of an inflation targeting regime on F. Impact of a one-unit increase in central

the sensitivity of expectations bank transparency on the sensitivity of
expectations
Source: Consensus Economics; International Monetary Fund; World Bank.

Note: Inflation expectations are long-term (five-year-ahead) expectations of annual inflation, measured at biannual
frequency. EMDEs = emerging market and developing economies.
A.-D. Sample includes 24 advanced economies (1990H1-2018H1 for panel A; 1995H1-2018H1 for panel C) and 23 EMDEs
(1995H1-2018H1 for panel B; 2000H1-2018H1 for panel D).
C.D. Inflation shocks are defined as the difference between realized inflation and short-term inflation expectations in the
previous period. Time-varying sensitivity is estimated by regressing the change in five-year-ahead inflation expectations on
inflation shocks. The model is described in Chapter 4. Solid lines indicate medians of estimates; dashed lines indicate 68
percent confidence intervals.
E.F. Bars represent coefficients in panel regressions of 24 advanced economies, 23 EMDEs, and all 47 economies, using
annual data for 1995-2016. The model is described in Chapter 4. Vertical lines denote 90 percent confidence intervals.
• How have exchange rate movements affected consumer price inflation over
time?
• How does the pass-through to inflation depend on the underlying shock

triggering the exchange rate movement?
• What country characteristics are associated with lower pass-throughs?
Their analysis is novel in several dimensions. First, they draw on event studies of
large currency movements and analyze shifts in the relationship between
exchange rates and inflation. This leads to empirical results that shed new light
on the heterogeneity of pass-through estimates across countries and over time.
Second, the chapter supplements a growing empirical literature linking the
exchange rate pass-through to underlying shocks, contrasting with traditional
reduced-form approaches that estimate an “average” pass-through based on the
assumption of an exogenously determined exchange rate. Third, compared with
earlier studies that have derived state-dependent pass-through estimates, their
work investigates a greater menu of shocks, uses a larger sample of countries, and
employs a state-of-the-art econometric framework that combines domestic and
global shocks.11 Finally, the chapter explores the role of some EMDE-specific
characteristics, including monetary policy frameworks, participation in global
value chains, and foreign currency invoicing.
This approach yields estimates of exchange rate pass-throughs that differ widely
by the source of shocks and country characteristics. The approach produces the
following results.
First, domestic shocks were the main driver of exchange rate fluctuations across
most countries but resulted in significantly different pass-throughs to inflation,
depending on the nature of the shocks (Figure 6). The pass-through associated
with domestic monetary policy shocks was generally higher, especially in
EMDEs without inflation targeting central banks.12 In contrast, domestic
demand shocks were typically accompanied by negative and mostly insignificant
pass-throughs, reflecting the offsetting effects of growth and exchange rate
channels (that is, weakening domestic demand giving rise to currency
depreciation and declining inflation).
11 Past empirical studies disentangling the impacts of different types of shocks on estimated
pass-throughs include Forbes, Hjortsoe, and Nenova (2017, 2018) and Shambaugh (2008).
12 The link between the adoption of inflation targets by central banks and declining exchange rate
pass-throughs has been investigated in some other studies, including Gagnon and Ihrig (2004), Mishkin
and Schmidt-Hebbel (2007), and Coulibaly and Kempf (2010).
Global shocks accounted for a smaller proportion of exchange rate movements

and their pass-through ratios varied widely, depending on country characteristics
and the type of shock. For instance, although global demand shocks were linked
to positive pass-throughs in many EMDEs, in some cases pass-throughs were
negative or insignificant. The pass-through for oil price shocks was mostly
positive for energy exporters, but widely divergent for energy importers.
Second, greater central bank independence was associated with significantly

lower pass-through ratios, highlighting a self-reinforcing feedback between
central bank credibility and price stability (Carriere-Swallow et al. 2016). The
insulation provided by central bank independence was evident in weaker pass-
throughs following domestic monetary policy, global demand, and oil price
shocks.
Third, evidence of a downward trend in average exchange rate pass-through

ratios over the past two decades is consistent with a broader movement toward
improved central bank policies and a more solid anchoring of inflation
expectations, as reported in Chapter 4. Other structural factors, including
growing integration in global value chains, may have played a role as well, but
cannot account for substantial cross-country differences in pass-through ratios.13
The authors argue that differences in shock-specific pass-through ratios could

have important implications for monetary policy. For example, the exchange rate
pass-through during an initial economic recovery phase could be low, reflecting
the predominance of domestic demand shocks. However, grounding subsequent
monetary policy tightening decisions on the assumption of a similarly low pass-
through could be misleading, since monetary policy shocks are typically
associated with much higher pass-through ratios. Failing to take these factors
into account may lead central banks to overshoot their objective, creating
unnecessary fluctuations in inflation and real economic activity.
PART C. Low-Income Country Considerations
Part C focuses on inflation and monetary policy–related challenges faced by

LICs. Chapter 6 delves into the problem of identifying drivers of inflation in
LICs. This is followed in Chapter 7 by an analysis of vulnerability to large food
price swings in LICs and the poverty implications.
13 Some studies have found that global value chain participation can reduce the response of import and
export prices to exchange rate movements in advanced economies and EMDEs (Amiti, Itskhoki, and
Konings 2014; de Soyres et al. 2018; Georgiadis, Gräb, and Khalil 2017). However, these effects were not
detectable in the estimated pass-throughs to consumer price inflation across countries.
FIGURE 6 Inflation and exchange rate pass-through

The frequency and severity of EMDE currency depreciations has declined since the 1990s.
Domestic shocks remain the dominant driver of exchange rate fluctuations but are
associated with different pass-throughs, from significantly positive for monetary policy
shocks to negative for domestic demand shocks. Global shocks accounted for a smaller
proportion of exchange rate movements and were associated with considerable
heterogeneity of estimated pass-through ratios. Greater central bank independence tends
to be linked to lower exchange rate pass-throughs, across countries and over time.
A. Frequency of EMDE currency depreciations B. Variance decomposition of exchange rate

movements
C. Pass-through: domestic shocks D. Pass-through: Global shocks
E. Central bank independence and F. Average pass-through

pass-through from monetary policy shocks
Source: World Bank.

Note: EMDEs = emerging market and developing economies.
A. Depreciations are defined as negative quarterly changes in the nominal effective exchange rate.
B. Median share of country-specific exchange rate variance accounted for by domestic, global, and exchange rate shocks.
C.-F. Pass-throughs are defined as the ratio between the one-year cumulative impulse response of consumer price inflation
and the one-year cumulative impulse response of the exchange rate change estimated from factor-augmented vector
autoregression models for 29 advanced economies and 26 EMDEs over 1998-2017. A positive pass-through means
that a currency depreciation is associated with higher inflation. Bars show the interquartile range and markers show
the cross-country median.
E. The central bank independence index is computed by Dincer and Eichengreen (2014). Low and high central bank
independence are defined as below and above the sample average.
F. Shock-specific pass-throughs are aggregated using shares of currency movements accounted for by each type of shock
as weights. This summary measure reflects the average sensitivity of inflation to exchange rate movements over the entire
estimation period. Full sample estimations are over 1971-2017 but can vary at the individual country level.
Chapter 6. Inflation in Low-Income Countries

Ha, Ivanova, Montiel, and Pedroni start their study of inflation in LICs with the
observation that, in recent decades, there has been a remarkable degree of
convergence in academic and policy circles in views about the principles to
which monetary policy should adhere to yield the low and stable medium-term
inflation that is conducive to healthy economic growth. Nevertheless, central
banks in LICs face significant challenges in achieving low and stable inflation
and anchoring inflation expectations (Mishra, Montiel, and Spilimbergo 2012).
Meanwhile, globalization has proceeded apace in LICs, as it has elsewhere,
magnifying, through several channels, the challenges confronted by LICs in
achieving these objectives.
Inflation rates in LICs over the past two decades have declined from
exceptionally high levels in many cases and converged closer to those of
advanced economies and other EMDEs, despite the special challenges faced by
LICs. The challenges include being susceptible to relatively large domestic as
well as external shocks. At the same time, global inflation has stabilized at low
rates.
These observations lead the authors to study to what extent the improvement in
LIC inflation performance over the past two decades reflects improved domestic
policies, as opposed to having been imported. The chapter also examines the
extent to which core inflation in LICs has remained stable in the face of a variety
of external shocks, including shocks to global core, energy, and food price
inflation, and other shocks transmitted to domestic economies through
exchange rate fluctuations. The authors address the following questions:
• How has inflation in LICs evolved?
• How well anchored are inflation expectations in LICs?
• What country characteristics have been associated with stronger anchoring?
The chapter extends the existing literature in several ways. First, it presents the
results of the first-ever investigation of the sensitivity of core inflation to various
inflation shocks, domestic and global, in a large group of countries over a long
period. The authors estimate a novel econometric model that helps identify the
global component of core inflation endogenously and produces a parsimonious
representation of the common and idiosyncratic components of core inflation
(Pedroni 2013). Second, the chapter is unique in its specific focus on LICs.
Third, the chapter reports findings on which country characteristics help explain
differences in the responses of core inflation to different types of shocks.
The authors report the following main results.
First, although LIC inflation has declined sharply from the mid-1990s, the level
and volatility of headline inflation have remained above those in advanced
economies (Figure 7).
Second, core inflation in LICs was more susceptible to external shocks—in
particular, to global core and food prices—than in the other country groups.
Around three-quarters of the variation in core inflation rates among LICs was
due to global shocks, compared with one-quarter in advanced economies. Global
food and energy price shocks accounted for 12 percent of core inflation variation
in LICs, half more than in advanced economies and one-fifth more than in non-
LIC EMDEs.
Third, domestic characteristics appear to matter for determining the
responsiveness of inflation to external shocks. Notably, LICs with fixed
exchange rates seem to succeed in anchoring inflation expectations as much as
other EMDEs with fixed exchange rates, whereas LICs with floating exchange
rates have had a much more difficult time.
This suggests that LIC central banks have not been able to secure low and stable
medium-term inflation rates on their own, and their improved inflation
performance may therefore have been largely imported. Therefore, if global
inflation were to rise, LICs would face the risk of their own inflation rising in
tandem, unless steps can be taken to improve their homegrown anti-inflation
credibility.
The next chapter extends the examination of the sensitivity of LIC inflation to
global shocks by considering the effects of global food prices on domestic food
prices and poverty.
Chapter 7. Poverty Impacts of Food Price Shocks and Policies

In August 2011, international food prices hit an all-time high. This followed the
2007-08 food price spike, which pushed an estimated 105 million people into
extreme poverty and prompted widespread concerns about the food security of
the poorest. Although food prices have been lower in recent years, they are still
significantly above their lows in 2000 (Figure 8). In Chapter 7, Laborde,
Lakatos and Martin ask three questions:
• How do food price shocks affect EMDEs and LICs?
• How do countries intervene to reduce the impact of food price shocks?

• What was the impact of the 2010-11 food price shock on poverty?
The study adds to the literature by quantifying the degree to which countries
intervened during this episode. The chapter also estimates the impact of the
FIGURE 7 Drivers of core inflation in low-income countries

Core inflation in LICs was more sensitive to global shocks than elsewhere. Around three-
quarters of the variation in core inflation rates among LICs was due to global shocks,
compared with one-quarter in advanced economies. Global food and energy price shocks
accounted for 12 percent of core inflation variation in LICs, half more than in advanced
economies and one-fifth more than in non-LIC EMDEs. Higher central bank transparency
and pegged exchange rate regimes have been associated with greater resilience of
domestic core inflation in LICs to global core inflation shocks.
A. Inflation volatility, by country group B. Contributions of global and domestic

shocks to core inflation variation
C. Contributions of global and domestic D. Contributions of global and domestic

shocks to core inflation variation, by shocks to core inflation variation, by central
exchange rate regime bank independence
Source: Dincer and Eichengreen 2014; Shambaugh 2004; World Bank.

Note: EMDEs refer to non-LIC EMDEs. EMDEs = emerging market and developing economies; LICs = low-income
countries.
A. Inflation volatility is measured as the standard deviation of annual inflation rates for the past 10 years.
B.-D. The results are based on a heterogeneous panel structural vector autoregression model with 104 countries
(25 advanced economies, 61 EMDEs, and 18 LICs) between 1970M2 and 2016M12. The forecast error variance
decomposition of core inflation is based on the median across countries within each group. The forecasting horizon is
18 months.
C. Exchange rate regimes are based on the classification by Shambaugh (2004).
D. Central bank independence is based on the central bank transparency index of Dincer and Eichengreen (2014). A
higher value of the index indicates a more transparent and independent central bank. “High” and “low” indicate countries
with above- and below-median central bank independence, respectively.
2010-11 food price spike and associated trade policy interventions on poverty
using a general equilibrium model complemented with data from household
surveys (Laborde, Robichaud, and Tokgoz 2013).
In some respects, the last two food price spikes (2007-08 and 2010-11)
resembled earlier, similar episodes: world prices rose rapidly, whereas domestic
prices increased only gradually. . In other respects, however, the 2010-11 spike
was different from previous episodes. The 2007-08 increase in food prices came
after a long period of stability in food prices (Ivanic and Martin 2008). In
2007-08, world prices of all staple foods increased steeply, led by a strong
increase in the world price of rice. Most countries reacted strongly, by
introducing insulating policies.14 In contrast, the 2010-11 episode occurred
when world markets and policies were still normalizing after the 2007-08
episode. Government interventions differed considerably across countries and
commodities, and insulating policies actually dampened the increase in world
rice prices.15
The analysis by Laborde, Lakatos, and Martin yields several major findings.
First, food prices can affect poverty through multiple channels, and the effects
depend on country characteristics.
• At the macroeconomic level, high shares of agriculture and food in total

output, consumption, employment, trade, and government revenues
heighten countries’ vulnerability to volatility in international food prices.
LICs are particularly susceptible, as agriculture in these countries accounts,
on average, for close to one-third of value added and two-thirds of total
employment, nearly three times their shares in other EMDEs. Additionally,
more than three-quarters of LICs are net food importers compared to only
half of other EMDEs. During the 2010-11 event, the increase in food prices
accounted disproportionately for the rise in inflation—about two-thirds of
the change in inflation in LICs and a little more than half in other EMDEs.
• At the microeconomic level, food price spikes are felt most severely by the
poor, since they are net buyers of food and a disproportionate share of their
income (two-thirds in LICs) is spent on food. Through these channels, food
price spikes raise poverty, reduce nutrition, and cut the provision of essential
services such as education and health care (World Bank 2011).
Second, the authors show that governments in EMDEs tend to respond

particularly strongly to sharp changes in world prices for staple foods—such as
rice, wheat, and maize—to smooth volatility. Domestic food prices are
considerably less volatile than world food prices in the short run. However, the
14 During the 2007-08 food price spike, close to three-quarters of EMDEs took policy action to
insulate their domestic markets from the sharp increase in world prices (World Bank 2009).
15 Important net rice exporters, such as India, Pakistan, and the Republic of Yemen, implemented
policy interventions that raised domestic rice prices more than the increase in the world price. In India, for
example, the abolition of export quotas in September 2011 (in place since 2007) coincided with the
agricultural marketing season and resulted in a surge of exports and a rise in domestic prices.
FIGURE 8 Poverty impact of food price shocks

High shares of agriculture and food in total output and consumption, employment, trade,
and government revenues heighten countries’ vulnerability to volatility in international food
prices. Insulating policies introduced during the 2010-11 food price spike accounted for 40
percent of the increase in the world price of wheat and one-quarter of the increase in the
world price of maize. Combined with government policy responses, the 2010-11 food price
spike increased global poverty by 1 percent, or 8.3 million.
A. Global food prices B. Share of food in total consumption

expenditure
C. Inflation in LICs D. Increase in world prices, 2010-11
E. Impact of the 2010-11 food price spike on F. Impact of the 2010-11 food price shock on
the number of extreme poor, by region the number of extreme poor, by policies
Source: Ag-Incentives Database, World Bank.

Note: EAP = East Asia and Pacific; EMDEs = emerging market and developing economies; LAC = Latin America and the
Caribbean; LICs = low-income countries; MNA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan
Africa.
A. Based on annual commodity price indexes, deflated using the World Bank manufactures unit value index.
B. Based on household survey data for 2010 on the share of food in total consumption expenditure of households.
C. Average inflation based on a sample of 12 LICs.
D.-F. Based on estimates using the computable general equilibrium model MIRAGRODEP, described in detail in Chapter 7.
E.F. Assuming increases in the price of maize, rice, and wheat, as represented in panel D and based on a poverty line of
$1.90/day purchasing power parity.
dampening effect of policies dissipates over time, and domestic prices tend to
match world prices in the long term.
Third, although individual countries can insulate their domestic markets from
short-term fluctuations in global food prices, these interventions can have the
perverse effect of making global food prices more volatile (Anderson, Martin,
and Ivanic 2017). Indeed, these policy interventions accounted for 40 percent of
the increase in the world price of wheat and one-quarter of the increase in the
world price of maize during the 2010-11 food price spike. In contrast,
government interventions in rice markets (in part, to reverse restrictions
imposed after the 2007-08 food price shocks) dampened the shock to world
prices by about 50 percent.
Fourth, overall, the 2010-11 food price spike may have increased the number of
poor by 1 percent, or 8.3 million, despite—and in part, because of—widespread
government intervention. The increase in world food prices, combined with
government intervention, was most strongly felt in countries such as Bangladesh,
India, and Uganda, where the extreme poor tend to be net food buyers whose
real incomes declined. Countries like Ethiopia and Nigeria implemented
insulation policies that reduced poverty.
Future research directions

The analysis in this book not only presents original analytical work on inflation
in EMDEs, but also suggests several new research avenues to be explored.
Decline in inflation. The discussion of long-term trend disinflation over almost

half a century invites future research in two directions. First, the relative
contributions of long-term structural changes—including technological
advances, globalization of trade and finance, and others—to global disinflation
over the past four to five decades could be more formally quantified. This could
be done in a general equilibrium framework, since most empirical models are
not well suited to uncovering the relationships between such slow-moving
variables. Second, future work could examine more formally the degree of global
comovement in long-term inflation trends, as Chapters 2 and 3 do for
comovement in short-term inflation movements. This could be set in the
context of a more sophisticated measure of trend inflation by extracting cycles at
different frequencies.
Global inflation and other sources of domestic inflation. Research on global

and EMDE inflation synchronization could be taken further in two directions.
First, rather than simply focusing on levels of development, the implications of
more granular country characteristics for synchronization could be explored,
such as commodity exporter status, regional trade links, and size of the tradables
versus nontradables sectors. Second, it would be useful to explore the extent to

which synchronization is driven by common shocks that affect all countries, or
by country-specific shocks that spill over between countries.
Inflation expectations. This book’s study of inflation expectations points to

several avenues for future research to explore. First, research could examine the
determinants of a wider range of measures of inflation expectations in EMDEs,
if data availability improved—for example, with the development of domestic
financial markets to provide market-based measures of expectations. Second, it
would be useful to consider nonlinearities between institutional factors and the
anchoring of inflation expectations. Additionally, there is a need to investigate
how complementarities between institutional factors and fiscal and monetary
policy frameworks help improve the anchoring of inflation expectations.
Exchange rate pass-through. Future work on this topic could more formally
investigate the relationship between estimated exchange rate pass-through and
structural factors, such as the degree of value chain participation and foreign
currency invoicing practices in EMDEs. This could take the form of event
studies around significant policy or other structural changes. The analysis of
shock-specific pass-through rates could also be extended to different inflation
measures, for example, import prices, producer prices, GDP deflator, and core
consumer prices. This could shed light on the source of incomplete pass-through
to consumer price inflation and help guide monetary policy decisions that are
robust to more volatile price components, including energy and food. Finally,
nonlinearities in exchange rate pass-through could be further investigated,
looking at the direction and size of the various shocks under consideration.
Inflation in LICs. The implications for the inflation outcomes of country-

specific characteristics in LICs remain to be explored. There is also a need to
understand which specific reforms to the operations of LIC central banks would
be most effective in achieving homegrown credibility. The latter topic has been
covered extensively for the advanced economies, but, given the particular
challenges faced by LICs, these priorities may well differ from those that have
worked elsewhere.
Despite the growing body of literature on food price stabilization policies,

several questions remain outstanding. Chapter 7 cautions about the unintended
consequences of government policies and highlights the need for a more formal
analysis of the effectiveness and development impact of targeted and untargeted
policy interventions. Since trade policy interventions are likely to continue to be
used, it would be useful to explore how policies—especially those coordinated at
the multilateral level—could be designed to reduce their negative effects.
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In this era of hyperglobalisation, are central banks still masters of
their domestic monetary destinies? Or have they become slaves to
global factors? … [t]here’s evidence of global inflationary cycles that
correspond with an intensifying globalisation that propagates
common shocks via commodity, trade and financial channels.
Mark Carney (2015)
Over the last decade there has been a growing interest in the
concept of “global inflation”. This is the notion that, in a globalised
world, inflation is becoming less responsive to domestic economic
conditions, and is instead increasingly determined by global factors.
Mario Draghi (2015)

PART A
INFLATION
Global and Domestic Drivers
CHAPTER 1
Inflation: Concepts, Evolution, and Correlates
In the past four to five decades, inflation has fallen around the world, with median
annual global consumer price inflation down from a peak of 16.6 percent in 1974 to
2.6 percent in 2017. This decline began in advanced economies in the mid-1980s
and in emerging market and developing economies in the mid-1990s. By 2000,
global inflation had stabilized at historically low levels. Lower inflation has been
accompanied by reduced inflation volatility, especially in advanced economies. This
improvement in inflation outcomes has stemmed in large part from structural
economic changes, including improved monetary and fiscal policy frameworks as well
as international trade and financial liberalization. Lower and more stable inflation
has often been associated with better growth and development outcomes, partly by
reducing uncertainty, fostering a more efficient allocation of resources, and helping
preserve financial stability.
Introduction
Inflation has declined sharply around the world since the global financial crisis.
Global inflation—defined as median consumer price inflation among all
countries—fell from 9.2 percent (year-on-year) in the second quarter of 2008 to
2.3 percent in the second quarter of 2018. In 80 percent of emerging market
and developing economies (EMDEs), inflation in the second quarter of 2018
ranged between 0.9 and 7.5 percent (year-on-year), compared with a range of
4.8 to 25.3 percent in the second quarter of 2008. Among EMDEs, this has
created room for monetary policy to support activity. In advanced economies,
however, persistent below-target inflation since the crisis has increased risks of
de-anchoring inflation expectations and led central banks to resort to
unconventional monetary policy instruments to support demand.
The recent easing of inflation continues a trend that spans nearly 50 years. After
a rapid rise during the 1960s, global inflation peaked in 1974 at 16.6 percent
(annual average), four times the global inflation in 2017 (Figure 1.1). Similarly,
inflation in EMDEs declined from a peak of 17.3 percent (annual average) in
1974 to 3.5 percent in 2017. The disinflation over the past four to five decades
has been the result of a confluence of factors, including the adoption of new
monetary and fiscal policy frameworks, severe global shocks, and structural
changes in national economies and the global economy.
Note: This chapter was prepared by Jongrim Ha, Anna Ivanova, Franziska Ohnsorge, and Filiz Unsal.
Annex 1.1 was prepared by Peter Nagle.
6 CHAPTER 1 I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
FIGURE 1.1 Global inflation

Global inflation fell sharply between 1970 and 2000. It has been low since then, a trend
shared by all measures of inflation. The post-crisis period of globally low inflation has
helped bring inflation into target ranges in the majority of EMDEs but has raised concerns
about deflation in advanced economies.
A. Global inflation B. Inflation in advanced economies and

EMDEs
C. Share of advanced economies and EMDEs D. Share of advanced economies with low
with inflation below or within target range inflation
E. Global core and headline inflation F. Global PPI, CPI, and GDP deflator inflation
Source: World Bank.

Note: All inflation rates refer to year-on-year inflation. CPI = consumer price index; EMDEs = emerging market and
developing economies; GDP = gross domestic product; PPI = producer price index.
A. Median consumer price inflation among 153 economies.
B. Median consumer price inflation of 29 advanced economies and 124 EMDEs.
C. Share of 11 advanced economies and 24 EMDEs with consumer price inflation below target or within target range. The
horizontal line indicates 50 percent.
D. Percent of 29 advanced economies with consumer price inflation below zero and between 0 and 2 percent. Horizontal
lines indicate 1970-2017 averages.
E. Median for 41 economies.
F. Median for 39 economies.
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S CHAPTER 1 7
Low and stable inflation has often been associated with more stable output and
employment and more rapid output growth and investment. Low and stable
inflation increases the transparency of relative price changes, provides confidence
for long-term savers and investors, protects the purchasing power of household
income and wealth, and enhances financial stability (Annex 1.1; Box 1.1). By
contrast, economies that have experienced high inflation have suffered
significantly lower growth (Kremer, Bick, and Nautz 2013). Extended periods of
chronically high inflation, often in Latin America, have frequently ended in large
output losses during stabilization programs, or even balance of payments crises.
Extremely low inflation, however, such as has prevailed in many advanced
economies over the past decade, may make it difficult for central banks to lower
real short-term interest rates sufficiently to provide the requisite stimulus to
demand, given that the lower bound on nominal rates is close to zero. Extremely
low inflation may therefore limit the room for maneuver of conventional
monetary policy and lead central banks to use unconventional measures,
including large-scale purchases of longer-term financial assets, to reduce longer-
term rates. Such difficulties in implementing expansionary monetary policy, in
turn, increase the risk of sliding into a self-reinforcing period of deflation that
raises debt burdens and further depresses activity. Extremely low inflation may
also hinder the adjustment of absolute and relative real wages, because of the
general downward rigidity of nominal wages.
Focus. This chapter focuses on the factors that have supported long-term
disinflation across the world. It also discusses the benefits from such long-term
disinflation. This complements the analysis of the drivers of short-term inflation
movements in Chapters 2 to 5. This chapter discusses the following questions:
• How does inflation support or hinder economic activity?
• How has global inflation evolved over the past four to five decades?
• What factors have contributed to these trends in global inflation?
Contribution to the literature. This chapter’s contributions are threefold.
First, it documents the broad-based disinflation over the past four to five decades
using a rich database of countries and inflation measures. The analysis is based
on a comprehensive data set for a virtually global sample of countries over
almost half a century (141 EMDEs and 34 advanced economies for 1970-2018).
Earlier studies have documented the broad-based global disinflation, but with
data sets that covered a narrower set of countries or a shorter time period. These
studies have been mostly restricted to advanced economies and have not taken
account of either the drop in the price of oil in 2014 or the period of unusually
depressed post-crisis inflation.
BOX 1.1 Benefits and costs of inflation: A review
Estimates of the optimal inflation rate lie in a wide range, depending on

country characteristics. Excessively high or low inflation can trigger self-
perpetuating output losses. Particular policy challenges arise in exiting from
high inflation and navigating very low inflation.
A large literature has documented the challenges posed by high inflation
for advanced economies and emerging market and developing economies
(EMDEs). In the 1970s and 1980s in advanced economies and until the
early 1990s in EMDEs, the perils of high inflation were the main
macroeconomic policy concern. By the early 2000s, at least for advanced
economies, the focus had shifted to the causes and consequences of very
low inflation, including deflation (that is, negative inflation). This
literature enjoyed a renaissance after the global financial crisis, as fears
about deflation mounted.
Against this backdrop, this box addresses the following questions:
• What output losses have been associated with high inflation?
• Why is high inflation associated with weak activity?

• What policy challenges does excessively low inflation pose?
What output losses have been associated with high inflation?
Adverse effects of high inflation on output have been studied extensively
since the 1990s.1 Early studies found that inflation above 40 percent was
associated with slower economic growth in large samples of countries from
the 1960s to the mid-1990s (Fischer 1993; Bruno and Easterly 1998;
Temple 2002). In most (31 of 41) episodes of inflation above 40 percent,
output losses were sharp (2.4 percent, on average), but they were not
significant at lower inflation levels (Bruno and Easterly 1998). Lower
inflation thresholds, typically below 20 percent, for a negative relationship
between inflation and growth were also reported by several subsequent
studies based on large samples of countries stretching over multiple
decades.2
1 The focus here is on the challenges of persistently high inflation. Bohl and Siklos (2018)
review hyperinflation episodes, when month-on-month inflation exceeded 50 percent.

2 See Espinoza, Leon, and Prasad (2012) for a literature review of thresholds in the relationship
between inflation and growth. Threshold effects are also estimated by Judson and Orphanides
(1999), Omay and Öznur Kan (2010), Bick (2010), and Lopez-Villavicencio and Mignon (2011).
BOX 1.1 Benefits and costs of inflation: A review (continued)
There is growing evidence that the threshold for a negative relationship

between inflation and growth depends on country characteristics. Some of
the earliest studies in this literature documented that the threshold tends to
be lower in advanced economies—below 10 percent, and typically around
2-3 percent—than in EMDEs, where inflation thresholds have been
estimated at around 20 percent.3 The range of estimates varies widely,
however. Some studies have estimated inflation thresholds at around 5-8
percent for Asian EMDEs and 7-9 percent for Sub-Saharan African
EMDEs.4 Country features that have been associated with a more negative
link between inflation and growth include greater financial development
and trade openness, larger government, weaker institutions, and greater
political risk.5
Why is high inflation associated with weak activity?
High inflation is likely to weaken activity by obscuring and distorting

relative prices, creating uncertainty that undermines long-term decision
making and discourages savings; redistributing incomes and thereby
weakening consumption; and eroding financial stability. Activity is also
likely to be weakened by the policies needed to reduce inflation from high
levels, including tighter monetary policies.6
Transparency of relative price changes. High inflation is likely to require

frequent price adjustments by firms to maintain their profitability. If price
adjustments for different goods and services are asynchronous (“staggered
price setting”), relative price distortions will result (Woodford 2003;
Fischer 1993). Even if temporary, these will tend to undermine the
efficient allocation of resources and productivity growth. In particular,
3 Khan and Senhadji (2001); Drukker, Gomis-Porqueras, and Hernandez-Verme (2005); Vaona
and Schiavo (2007).

4 Ndoricimpa (2017); Thanh (2015); Vinayagathasan (2013).
5 In a large sample for 1950-2009 or 1960-2009, Ibarra and Trupkin (2011, 2016) and Eggoh
and Khan (2014) find that, on average, inflation above thresholds of 19 and 12 percent,
respectively, are associated with lower growth. However, the negative association between inflation
and growth is stronger in countries with greater financial depth, broader trade openness, higher
investment, and larger government expenditures. The threshold is in the single digits for EMDEs
with the highest quality political institutions and most favorable International Country Risk Guide
ratings of political risk.
6 See Mishkin (2008b); Camba-Mendez, Garcia, and Rodriguez-Palenzuela (2003); and Briault
(1995) for more detailed literature reviews.

inflation may encourage investment in property rather than more

productive investments (White 2006). If high inflation obscures relative
price changes, it also creates a need for costly information search (Aksoy et
al. 2017).
Uncertainty. High inflation may make it difficult for households and firms
to disentangle relative from absolute price changes (Lucas 1972). High
inflation is also typically associated with more volatile inflation (Logue and
Willet 1976; Andersen and Gruen 1995; IMF 2001). Finally, high and
volatile inflation signals an inability of government policies to ensure
macroeconomic stability (Fischer 1993). These factors increase uncertainty
about the future value of assets and hence discourage investment that
requires solid long-term returns to ensure profitability (Woodford 2003).
Such investment can be an important source of productivity growth,
especially when it embodies new technologies (Greenwood, Hercowitz,
and Krusell 1997).
Erosion of after-tax and real incomes. High inflation may reduce saving
through two channels. First, it lifts nominal income growth and, thus,
accelerates tax progression when rising nominal incomes are measured
against fixed nominal income tax brackets (Greville and Reddell 1990;
Feldstein 1997, 1999). This squeezes post-tax incomes, which will tend to
depress household saving. Second, high inflation reduces the real value of
debt—which serves as an investment vehicle for household savings—and
any income derived from it (Briault 1995). The erosion of after-tax
incomes and income derived from debt discourages savings and, hence, the
funding envelope for productive investment.
Risks to financial sector stability. With high inflation, households will

tend to shun financial instruments carrying fixed nominal returns and thus
withdraw from bank-intermediated savings. Such disintermediation may
force banks to rely on non-deposit liabilities, which will tend to raise the
(short-term) cost of financing their (long-term) investment portfolios. This
will raise the maturity risks inherent in the balance sheets of financial
intermediaries that hold long-term assets, often at fixed interest rates,
against short-term liabilities (Schwartz 1995). Furthermore, high inflation
will raise the term premia and maturity risks embodied in long-term
interest rates that compensate investors for long-term inflation risks. The
resulting higher borrowing costs increase rollover or default risk and the
cost of financing long-term investments (Wright 2011).7
Income redistribution that weakens consumption. Low-income
households tend to rely on wages, pensions, and social benefits as their
main sources of income and hold a larger share of their savings in cash
(Erosa and Ventura 2002). Wages, pensions, and social benefits tend to
respond less and with longer lags to inflation than nonwage income, and
the real value of cash savings, being unremunerated, is eroded by inflation
(Kahn 1997). As a result, poor households’ real incomes tend to decline
more than those of higher-income households in high-inflation
environments (Romer and Romer 1997; Albanesi 2007).8 Since poor
households have a higher marginal propensity to consume—for example,
as shown by Dynan, Skinner, and Zeldes (2004) for the United States—
this tends to weaken consumption.
Exiting high-inflation episodes. The detrimental effect on growth of high
inflation is well established in the literature, although precise thresholds
vary. Additional damage to output is done when the necessary measures
are taken to exit high inflation. Indexation of wages and other prices can
make large output losses necessary to achieve disinflation, especially when
central banks lack credibility (Blanchard and Gali 2007). (See Annex 1.3
for U.S. experience with disinflation.)
What policy challenges does excessively low inflation pose?
The low inflation of the early 2000s raised concerns about the ability of
central banks in advanced economies to support demand when policy rates
are near the zero lower bound (Reifschneider and Williams 2000;
Eggertsson and Woodford 2003). An extended period of low inflation
(“lowflation”) can distort resource allocation, present policy challenges in
7 The long-term interest rates can be decomposed into (i) expected inflation, (ii) expectations
about the future path of real short-term interest rates, and (iii) a term premium that reflects
changes in the perceived riskiness of longer-term securities and their liquidity. Term premiums on
longer-term securities will be higher when investors are more risk-averse and/or the perceived risk
of holding those securities is high. Historically, the most important risk for long-term bondholders
has been the risk of unexpected inflation. Uncertainty about the near-term outlook for the
economy or monetary policy also raises the riskiness of bonds.
8 In addition, poor households often lack access to financial technologies that allow hedging
against inflation (Mulligan and Sala-i-Martin 2000). Conversely, those poor households that do
have access to credit may benefit from inflation because it erodes the real value of nominal claims
such as loans (Doepke and Schneider 2006).
responding to recessions, and undermine the credibility of central banks.9

Once entrenched, deflation can trigger a spiral of self-reinforcing output
losses.
Lowflation. When inflation is extremely low—meaning significantly below
the target—relative price declines may require negative inflation in
categories of goods and services with excess supply. This presents a
challenge when rigidities prevent nominal price cuts of goods and services
(Taylor 2000). When nominal prices cannot be reduced, low inflation can
lead to distorted relative prices and inefficient allocation of resources across
the economy.
Low inflation also poses monetary and fiscal policy challenges. Low
inflation is typically associated with low nominal monetary policy rates. In
such an environment, monetary policy may be unable to respond with
conventional tools to negative shocks that reduce economic activity and
inflation, since the interest rate cuts that are needed to support activity
would imply negative nominal monetary policy rates. Two decades ago, it
was thought that monetary policy rates could not fall below zero—the so-
called “zero lower bound”—because of the incentive this would create for
moving out of financial instruments into cash (Svensson 2003). The
resulting disintermediation could undermine monetary policy effectiveness
and capital markets. Since 2010, however, the experiences of Denmark, the
Euro Area, Japan, Sweden, and Switzerland indicate that mildly negative
interest rates can be sustained for extended periods without causing large-
scale financial disintermediation (Arteta et al. 2016; Rogoff 2015).
However, the limited room for monetary policy action amid very low
inflation and short-term interest rates implies that fiscal policy has to
shoulder more of the responsibility for macroeconomic stabilization
(Feldstein 2002). Such proactive fiscal policy may be difficult when
government debt is high, because, all else equal, the real burden of debt is
likely to remain persistently higher in a lowflation environment than in an
inflationary environment where nominal incomes are rising (Contessi, Li,
and De Pace 2014).
Deflation. Outright deflation, if sustained over an extended period, can
reduce output by dampening investment and consumption and distorting
resource allocation (Fisher 1933; Friedman and Schwartz 1963). Deflation
9 Ciccarelli and Osbat (2017); Moghadam, Teja, and Berkmen (2014).

increases the real burden of debt and debt service and depresses collateral
values, thus straining financial systems (“debt deflation”) (Bernanke and
James 1991; End et al. 2015; Baig et al. 2003). It compresses price
dispersion and dulls the signals of relative price changes that are critical for
an efficient allocation of resources (Benabou 1992). Once deflation
becomes entrenched in expectations, it may become self-reinforcing
(Branch and Evans 2017; Banerjee and Mehrotra 2018). By raising real
interest rates, negative inflation tightens monetary conditions and
depresses activity further (Bernanke, Reinhart, and Sack 2004). Although
these mechanisms suggest that theoretically deflation could impose heavy
costs, empirical evidence suggests that these costs are modest in practice
(Borio et al. 2015).
The optimal inflation rate
The jury is still out on the optimal inflation rate. Theoretical models offer
a wide range of optimal inflation rates, negative and positive, depending
on the assumptions. Diercks (2017) analyzed 100 studies that provided
quantitative estimates for optimal inflation. Of these, about 80
recommended inflation targets at or below zero. Negative inflation would
ensure that real interest rates are positive even when nominal interest rates
are zero, such that there is no cost for holding money. However, these
models typically assume perfect price flexibility. Models with sticky prices
generate temporary deviations in relative prices and, hence, give rise to
allocative inefficiencies and welfare cost from inflation or deflation. These
models typically suggest an optimal inflation rate of zero. In models that
incorporate additional constraints that arguably add realism—such as
sticky wages, a zero lower bound on nominal interest rates, distortionary
taxation, financial frictions, and price indexation—a low positive inflation
rate becomes optimal.
The empirical literature suggests that optimal inflation rates lie in a wide
range, depending on country characteristics (Anand, Prasad, and Zhang
2015; Mankiw and Reis 2002). “Too high” inflation and deflation are
associated with output losses, and “too low” inflation carries the risk of
slipping into deflation in the next recession. The threshold for considering
inflation to be “too high” varies widely with country characteristics, and
the threshold for “too low” depends on the size and frequency of adverse
shocks, fiscal policy flexibility, and the effectiveness of monetary policy
transmission.

Given these trade-offs and risks, some studies (Blanchard, Dell’Arricia, and
Mauro 2010; Ball 2014; Krugman 2014; Kiley and Roberts 2017;
Andrade et al. 2018) recommend raising central banks’ inflation targets to
4 percent, which is double the median inflation target of advanced
economy inflation targeting central banks (2 percent). However, other
authors (Coibion and Gorodnichenko 2012; Coibion, Gorodnichenko,
and Wieland 2012; Mishkin 2018; Dorich et al. 2018; Schmitt-Grohe and
Uribe 2010) caution that raising the inflation target is too blunt a solution
for addressing risks around the zero lower bound: a higher inflation target
imposes higher economic cost most of the time, but it lowers the cost of
hitting the zero lower bound only in rare circumstances.
Second, in contrast to earlier studies, this chapter identifies a rich set of stylized
facts that are robust across different measures of inflation. Trend disinflation
over the past four to five decades manifested in all measures of inflation
(headline and core consumer prices, producer prices, import prices, and the gross
domestic product (GDP) deflator).
Third, the chapter provides a uniquely comprehensive and systematic analysis of
the structural factors that have been credited with lowering inflation over the
past four to five decades. The literature has identified many structural changes
that have supported the long-term trend toward lower and more stable inflation.
These include increased global economic integration and strengthened
macroeconomic policy frameworks. However, no study to date has presented a
systematic analysis of the role of these factors. This chapter provides such an
analysis as well as a preliminary quantification of their associations with the
trend decline in inflation.
Findings. The chapter documents the following findings:
• Inflation has fallen around the world. Median consumer price inflation
declined from a peak of 16.6 percent (annual average) in 1974 to 2.6
percent in 2017. Similarly, median inflation in EMDEs declined from a
peak of 17.3 percent (annual average) in 1974 to 3.5 percent in 2017, and,
in low-income countries (LICs) it declined from a peak of 24.9 percent
(annual average) in 1994 to 5.0 percent in 2017. The decline began in
advanced economies in the mid-1980s and in EMDEs in the mid-1990s. By
2000, global inflation had stabilized at historically low levels. Lower
inflation was accompanied by lower inflation volatility, especially in
advanced economies.
• Structural economic changes have supported global disinflation. The most

significant drivers of global disinflation have included globalization—
increased international economic integration—and a shift toward more
effective and more resilient monetary and fiscal policy frameworks and
exchange rate regimes. On average, inflation has declined faster in countries
with greater trade and capital account openness, more transparent central
banks, and a switch to inflation targeting regimes.
• The current low and stable inflation environment resembles those of the
Bretton Woods fixed exchange rate system from the post-war period to
1971 and of the gold standard of the early 1900s. All three episodes are
characterized by inflation below 5 percent for an extended period (7-19
years), but the current environment differs from the two earlier episodes in
its lower inflation volatility.
• The gains of the past four to five decades in terms of inflation are by no
means guaranteed. Inflation can easily make a comeback if the fundamental
structural and policy changes that have compressed inflation over the past
four to five decades lose momentum or even reverse. However, as long as
strong monetary policy frameworks are supported by sound fiscal policies
and institutional structures, it would be possible to keep in check the
inflationary implications of fluctuations in business and financial cycles, and
movements in commodity prices.
Conceptual considerations
Before exploring the longer-term drivers of inflation, several conceptual issues
require clarification. These include the relationship between inflation and
relative price changes, the interpretation of different measures of inflation, the
appropriate rate of inflation as a policy objective, and the implications of
inflation volatility and persistence.
Inflation versus relative price changes. Inflation refers to a sustained and broad-
based increase in the overall price level.1 This is distinct from changes in relative
prices, which measure the price of one good or service relative to the price of
another (or a weighted average of all other goods and services) and signal
information about relative surpluses or shortages in different product markets. A
rising relative price of a certain good or service indicates that the demand for it
outstrips supply and encourages production while discouraging consumption.
Hence, in contrast to inflation, relative price movements are critical for the
1 When the word “inflation” was first used in economic contexts in the early- to mid-19th century, it
referred to growth of the money supply. In the 1930s, it began to be associated with rising prices, which
were attributed to growing money supply (Bryan 1997, 2002).
efficient allocation of resources. If goods, services, and factor markets were fully
flexible, inflation (which in principle involves no change in relative prices) would
not affect the allocation of resources and relative price changes would occur
without inflation. However, if nominal rigidities limit the scope for downward
price adjustments, then broad-based inflation can facilitate relative price
adjustments by allowing above-average price increases for goods, services, or
factors of production that are in high demand (Taylor 2000). This is particularly
relevant to the market for labor because of the general downward rigidity of
nominal wages.
Disinflation versus deflation. Deflation refers to negative inflation—that is, a
decline in price levels—whereas disinflation refers to a decline in inflation rates
that are still positive (Federal Reserve Bank of San Francisco 1999). Disinflation
has been widespread since the mid-1970s, whereas outright deflation has
been rare.
Headline versus core inflation. Headline inflation usually refers to changes in
the prices of all goods and services in a basket of goods and services that is
representative of consumer expenditures. Core inflation measures are intended to
capture the underlying, common trend in all prices, regardless of relative price
changes. In practice, core inflation is often measured by excluding from the
calculation movements in the prices of goods and services that are most volatile,
in particular food and energy. For example, swings in food and energy prices
tend to be changes in relative prices that shift consumption and production
patterns. Alternatively, core inflation is sometimes calculated as the common
component of price movements of all goods and services (Stock and Watson
2007, 2010; Schembri 2017).
Consumer prices, producer prices, and GDP deflators. The most common
measure of inflation is the percentage change in the headline consumer price
index (CPI), which captures the cost of living of the average consumer. The CPI
includes domestically produced and imported consumer goods. The producer
price index (PPI), in contrast, reflects the prices charged by domestic producers
of goods and services.2 Domestically produced goods and services can have
several purposes, including domestic consumption, domestic investment, and
exports. When the composition of consumption differs from that of production,
for example, because of large consumer goods imports or extensive production of
investment goods, CPI and PPI inflation can diverge materially. Finally, the
2 The wholesale price index (WPI) is closely related to the PPI but, in principle, refers to sales in the
wholesale market, whereas the PPI refers to all sales. In the United States, for example, the WPI was
renamed the PPI in 1978 (Bureau of Labor Statistics). In contrast, the personal consumption expenditure
index is closely related to the CPI but, in contrast to the CPI, includes services not directly paid for by
consumers, for example, employer-paid services such as medical insurance.
GDP deflator measures the average price of the economy’s output, broadly
defined. It differs from the CPI by excluding import prices but including prices
of exports, investment, and government consumption. It differs from the PPI by
including taxes net of subsidies. The emphasis in this chapter is on the CPI,
because it offers the largest possible cross-country sample, especially at monthly
and quarterly data frequencies, and it is the measure targeted by the largest
number of central banks.
Contemporaneous quarterly movements in quarter-on-quarter CPI and PPI

inflation tend to be correlated (about 70 percent). The correlations for the CPI
and PPI with the GDP deflator are considerably lower (below 50 percent). In
more closed EMDEs, the correlation between the CPI and PPI is almost
complete (95 percent). In contrast, in more open economies, exports and
imports drive a wedge between consumption and production such that the
correlation of CPI and PPI is only 62 percent. Similarly, in advanced economies
more than in EMDEs, taxes and subsidies drive a wedge between the PPI and
the GDP deflator; as a result, the correlation between the PPI and the GDP
deflator in advanced economies is two-thirds that in EMDEs (Figure 1.2).
Inflation rates and volatility. In the absence of large commodity price or

exchange rate shocks, high and accelerating inflation rates signal an economy in
which aggregate demand outpaces aggregate supply. High inflation volatility is
often associated with macroeconomic instability and uncertainty about the
future path of prices. High inflation persistence near target levels—a tendency of
inflation to stay near its recent values, absent economic forces that move it away
from the current level—indicates that monetary policy has helped anchor
inflation expectations and reflects structural features of the economy such as
wage or price indexation (Fuhrer 2009).
Inflation and economic activity

Historically, low and stable inflation, combined with well-anchored inflation
expectations, has been associated with greater short-term stability of output and
employment and higher long-term growth.
Lower inflation has tended to be accompanied by lower inflation volatility and
higher output growth. Lower inflation volatility, in turn, has typically been
accompanied by lower output growth volatility and higher investment and
savings (Figure 1.3). Several channels account for the beneficial effects of low
and stable inflation on economic activity. These include greater predictability for
investors and households, greater transparency of relative price changes, and
greater financial stability. The large literature documenting these channels is
summarized in Box 1.1. The following provides a short summary:
FIGURE 1.2 Correlation between inflation measures

Movements in CPI and PPI inflation tend to be highly correlated, especially in more closed
EMDEs. In advanced economies especially, taxes and subsidies drive a wedge between
CPI and PPI inflation and GDP deflator inflation, such that their correlations are lower than
in EMDEs.
A. Correlation for advanced economies and B. Correlation among EMDEs

EMDEs
Source: World Bank.

Note: Correlation coefficients for quarter-on-quarter seasonally adjusted (not annualized) inflation among 53 economies (of
which 23 are EMDEs) for which CPI, PPI, and GDP deflator data are available. CPI = consumer price index; EMDEs =
emerging market and developing economies; GDP = gross domestic product; PPI = producer price index.
B. Trade openness measured as the sum of exports and imports as a percentage of GDP.
• First, low inflation reduces uncertainty. By inspiring confidence in the

future real value of nominal assets and reducing the uncertainty surrounding
future returns on productive investment, low and stable inflation fosters
long-term investment. Such investment can be an important source of
productivity and income growth, especially when new technologies are
embodied in investment.
• Second, low and stable—but positive—inflation makes relative price
changes more transparent. This reduces the need for costly search for
information that would be required when high inflation obscures relative
price changes.
• Third, low and stable inflation helps preserve the real value of after-tax
incomes, especially when tax brackets are fixed in nominal terms, and
savings (Box 1.1). This encourages investment and saving.
• Fourth, low and stable inflation tends to be associated with greater financial
sector stability. This, in turn, supports macroeconomic stability. Stable
inflation is usually associated with lower long-term nominal interest rates.
This can help reduce rollover or default risk and the cost of financing for
long-term investments. Stable inflation also reduces the risks faced by
financial intermediaries that hold long-term nominal assets.
FIGURE 1.3 Inflation and economic activity in EMDEs

Low and stable inflation has been associated with higher and more stable output growth,
and investment and savings.
A. Inflation volatility by inflation level B. Growth volatility by inflation volatility
C. Growth, by inflation level and volatility D. Savings and investment rates by inflation
volatility
Source: World Bank.

Note: The sample includes 84 EMDEs, including 20 low-income countries. Inflation volatility is defined as the standard
deviation. Inflation refers to year-on-year inflation. EMDEs = emerging market and developing economies; GDP = gross
domestic product.
A, Average inflation volatility from 1980 to 2016 for countries with average inflation in the top quartile and average inflation
in the bottom quartile.
B. Average real GDP growth volatility from 1980 to 2016 for country-year pairs with inflation volatility in the top quartile and
average inflation volatility in the bottom quartile.
C. Average real GDP growth from 1980 to 2016 for countries with average inflation (left column and bar) or standard
deviation of inflation (right column and bar) in the top quartile and average inflation in the bottom quartile.
D. Average savings and investment from 1980 to 2016 for countries with a standard deviation of inflation in the top quartile
and standard deviation of inflation in the bottom quartile.
Evolution of global inflation

Globally, inflation fell sharply from its 1974 peak of 16.6 percent, to 2.6 percent
in 2017. This decline began in advanced economies in the mid-1980s and in
EMDEs in the mid-1990s. By 2000, global inflation had stabilized at historically
low levels. Lower inflation has been accompanied by lower inflation volatility,
especially among advanced economies. The current environment of low and
stable inflation resembles that during the Bretton Woods fixed exchange system
in the post-war period up to 1971 and the gold standard of the early 1900s. This
section discusses the developments in detail.
Data. The analysis rests on a comprehensive database of inflation measures and

the key drivers of inflation. Data on headline, core, energy, and food CPI
inflation; PPI inflation; and GDP deflators, as well as their components, are
available for up to 175 countries for 1970-2017 (34 advanced economies and
141 EMDEs, of which 27 are LICs). The data were assembled from a wide
range of sources, including ILOSTAT, UNdata, OECDstat, International
Financial Statistics, Haver Analytics, internal World Bank databases, and various
editions of the International Monetary Fund (IMF) World Economic Outlook
database. These inflation series are complemented with data on inflation targets,
central bank independence, exchange rate regime, inflation expectations, and
international trade and financial openness. Global inflation is defined as median
CPI inflation, unless otherwise specified. The details of the database can be
found in the Appendix.
Trend disinflation, 1970-2017. Since its peak in the mid-1970s, global
inflation has been on a declining trend. Global inflation fell from a peak of 16.6
percent (annual average) in 1974 to 2.6 percent in 2017 (Figure 1.4). In
EMDEs, inflation declined from a peak of 17.3 percent (annual average) in
1974 to 3.5 percent in 2017; in LICs, it fell from a peak of 24.9 percent (annual
average) in 1994 to 5.0 percent in 2017. The trend decline started earlier (in the
mid-1980s) in advanced economies than in EMDEs and LICs (in the mid-
1990s) (Box 1.2).
In EMDEs, this disinflation process cut across all regions, including those with a
history of persistently high inflation, such as Latin America and the Caribbean
and Sub-Saharan Africa. The downward trend has manifested in all inflation
measures, including headline CPI, core CPI, PPI, and GDP deflator inflation.
By the early 2000s, the disinflation was largely completed, although it resumed
after the global financial crisis at a milder pace.
The “near-universal” character of disinflation since the mid-1970s was already
recognized by Rogoff (2003), but most other studies have focused on advanced
economies. The widely shared disinflation in advanced economies has been
attributed partly to common terms-of-trade shocks, such as oil price swings
(Rogoff 2003). Among Group of Seven economies, it may also have reflected
changes in monetary policy regimes, including the increased focus on price
stability, which also occurred during the early 1980s and early 1990s (Cecchetti
et al. 2007; Levin and Piger 2006).
Other factors may have included sounder fiscal policies, deregulation,
globalization, and, in the 1990s, accelerating productivity growth in parts of the
world (Rogoff 2003; IMF 2006). Studies of disinflation in EMDEs have focused
on specific policy experiments in individual countries, such as the introduction
of inflation targeting, greater exchange rate flexibility, or macroeconomic
FIGURE 1.4 Global inflation trends

Since its peak in the mid-1970s, global inflation has been on a decline. The decline began
in the mid-1980s among advanced economies before moving to EMDEs and low-income
countries in the mid-1990s. This disinflation process cut across all EMDE regions and
manifested in all inflation measures. By the early 2000s, the disinflation was largely
completed and resumed only after the global financial crisis, albeit at a more modest pace.
A. Global CPI inflation B. Global CPI trend inflation
C. Median CPI headline inflation, by region D. Median CPI headline inflation, by country
group
E. Median CPI, PPI headline inflation, and the F. Median core, food, and energy CPI inflation
GDP deflator
Source: World Bank.

Note: All inflation rates refer to year-on-year inflation. CPI = consumer price index; EMDEs = emerging market and
developing economies; GDP = gross domestic product; LICs = low-income countries; PPI = producer price index.
A. Based on 153 countries. The last observation is 2017. The values show headline inflation.
B. Based on 77 countries, including 50 EMDEs. The values show median trend inflation, as defined in Stock and Watson
(2016).
C. The horizontal lines reflect median inflation across all EMDEs over 1970-97 and 1998-2017. EAP = East Asia and
Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean; MNA = Middle East and North Africa;
SAR = South Asia; SSA = Sub-Saharan Africa.
D. Median of inflation trend of 25 advanced economies, 97 EMDEs (excluding LICs), and 27 LICs. The last observation is
2017:1.
E. Based on data for inflation in 39 countries, including 15 EMDEs.
F. Based on data for inflation in 47 countries, including 18 EMDEs.
BOX 1.2 Inflation in low-income countries
Inflation in low-income countries has declined sharply over the past three
decades, to a median of 5.0 percent in 2017 from a peak of 24.2 percent in
1994. This decline in inflation was broadly shared. It has been supported by
the move to more flexible exchange rate regimes, greater central bank
independence, lower government debt, and a more benign external
environment.
The number of low-income countries (LICs) has almost halved since
1994. As of 2018, 34 countries were classified as “low income” according
to the World Bank definition, down from 64 in 1994, following the
graduation of 31 mostly metals-exporting and transition economies to
middle-income status (Annex 1.2). Today, LICs are predominantly
agriculture-based, small, and fragile, and they tend to have weak
institutions (World Bank 2015). All but seven of them are in Sub-Saharan
Africa.
Today’s LICs have made large strides in stabilizing their economies over
the past five decades, with sharp declines in inflation and inflation
volatility. This box documents the achievements in terms of inflation.
Chapter 6 delves into the features of LIC inflation and quantifies its
drivers in depth. Against this backdrop, this box discusses the following
questions:
• How has inflation evolved in LICs?
• What factors have supported inflation developments in LICs?
Evolution of inflation
Among LICs, median inflation has fallen by two-thirds since 1970, to 5.0
percent in 2017—broadly in line with inflation developments in other
emerging market and developing economies (EMDEs). The inflation
decline has been broad-based across countries as well as inflation
components. As a result, the wide heterogeneity of inflation among LICs
in the 1990s has narrowed sharply, to a range of 6-18 percent in 2017.
1970s to 1990s. Throughout these three decades, median inflation among
LICs was 9-10 percent. Although this was broadly in line with inflation in
other EMDEs, LIC inflation underwent bouts of sharp spikes (to 25
percent), especially in the early 1990s, amid exchange rate crises. In half
the years between 1970 and 2000, the majority of LICs had double-digit
inflation.
BOX 1.2 Inflation in low-income countries (continued)
FIGURE 1.2.1 Inflation in low-income countries

Inflation and inflation volatility in LICs have declined since 1970, broadly in line
with other EMDEs. The decline has been broad-based across countries and
components of inflation.
A. Inflation B. Inflation
C. Number of LICs by inflation bracket D. Inflation volatility
Source: Haver Analytics; International Monetary Fund; World Bank.

Note: Data for 29 low-income countries and 83 other EMDEs. Inflation refers to year-on-year inflation.
EMDEs = emerging market and developing economies; LICs = low-income countries.
A. Blue lines are cross-country medians of inflation; dashed lines indicate the interquartile range across
28 LICs.
B. Cross-country medians.
C. Number of LICs in which inflation was in the bracket indicated. Data for 2017 not yet available for
some LICs.
D. Cross-country medians over rolling standard deviations.
2000s. During the 2000s, median inflation in LICs fell rapidly, to 5.0
percent in 2017 from a peak of 24.2 percent in 1994 (Figure 1.2.1). This
decline was broad-based and narrowed some of the wide heterogeneity in
inflation among LICs. In one-third of LICs, inflation in 2017 was less
than one-third its level in 1970. In an even larger number (58 percent) of
LICs, inflation in 2017 was less than one-third of its 1994 level. By 2008,
the two hyperinflation episodes in LICs (with inflation in excess of 1,000
percent) had also subsided. In 2017, inflation was in the single digits in
more than three-quarters of LICs, compared with less than one-fifth in
1994. Since 1970, core, food price, and energy price inflation have also
declined, as has inflation volatility (although it remains well above
inflation volatility in other EMDEs).
Factors supporting inflation developments
In every year since 2000, except 2002 and 2017, LIC inflation has
exceeded inflation in other EMDEs. This difference has been attributed to
several factors, of which three have been particularly closely examined:
fiscal policy, supply shocks, and uncertainty about monetary policy
transmission.
Fiscal policy. For LIC governments with weak revenue-raising capabilities

and an absence of well-functioning capital markets, inflation may become
an important source of financing fiscal deficits (Baldacci, Hillman, and
Kojo 2004). The presence of large fiscal deficits or high government debt
in LICs can cause fiscal dominance—with fiscal policy relying on
accommodative monetary policy to ensure fiscal sustainability (Baldini and
Poplawski-Ribeiro 2011; Weidmann 2013). In almost every year between
1992 and 2002, two-thirds of LICs had higher debt-to-GDP ratios than
the one-third of non-LIC EMDEs with the highest debt levels. In half the
years between 1995 and 2017, the median fiscal deficit in LICs was above
that in non-LIC EMDEs. Weak institutions (Bleaney, Morozumi, and
Mumuni 2016) and political instability (Aisen and Veiga 2006) may
reinforce the negative association between budget deficits and inflation.
Supply shocks. LIC economies are particularly vulnerable to frequent

supply shocks, especially weather-related ones. Agriculture sectors tend to
be large; poor transport links prevent risk sharing; and food forms a larger
share of household consumption (Bleaney and Francisco 2018; Cachia
2014; Chapter 6). As a result, for example, rainfall appears to have a
significant effect on economic growth in EMDEs in Sub-Saharan Africa
but not elsewhere (Barrios, Bertinelli, and Strobl 2010).
Uncertainty about monetary policy transmission. In LICs, credit and

other financial markets tend to be shallow; contract enforceability is
limited; and information asymmetries are pervasive, and many LICs retain
elements of financial repression in the form of interest rate controls
(Mishra, Montiel, and Spilimbergo 2012). This can impair monetary
policy transmission (IMF 2015; Mishra and Montiel 2013).
Since 2000, improvements in LIC policies and a benign global

macroeconomic environment have supported the decline in LIC inflation.
That said, policy frameworks in the median LIC remain generally weaker
than those in other EMDEs.
Improved policies. Inflation has tended to be lower in LICs with lower

public debt ratios, fixed exchange rate regimes, and higher degrees of
central bank independence and transparency (Figure 1.2.2). Since 1970,
monetary policy frameworks have strengthened in LICs. The index of
central bank independence (available for 10 LICs) doubled between 1998,
when the series starts, and 2014, when the series ends. In 1970, all but two
LICs had pegged exchange rates whereas, in 2017, only half the LICs (14
of 29 with available data) had fixed exchange rate regimes, as defined in
Shambaugh (2004). Fiscal pressures on monetary policy also appear to
have eased. Government debt has declined from a peak of 123 percent of
GDP, on average, in 2003 to 52 percent of GDP, on average, in 2017—
broadly in line with the average non-LIC EMDE. In addition, the
relationship between fiscal position and inflation appears to be nonlinear:
in a low-inflation environment, fiscal deficits tend to be less inflationary
(Catao and Terrones 2005; Lin and Chu 2013). As a result, the current
low-inflation environment may help further mute the pressures from fiscal
dominance on inflation in LICs.
More benign external environment. LIC economies, on average, have
become more open to trade and finance since the 1970s, although they
remain less open than other EMDEs (IMF 2011a).1 Higher capital account
openness, in particular, has been associated with lower inflation, whereas
there has been little difference between LICs that have been highly open to
trade and those that have not. Despite a growing number of LICs
switching to floating exchange rate regimes, exchange rates have been
considerably more stable since 1998 than in the preceding two decades.
This has helped lower LIC inflation volatility and inflation.
Conclusion
LIC inflation and inflation volatility have fallen sharply during the past
three decades, broadly in line with other EMDEs. The decline has been
broad-based across countries, as well as across components of inflation.
Both better policies—such as greater central bank independence and
transparency, a shift away from pegged exchange rate regimes, and lower
government debt burdens—and a more benign global macroeconomic
environment have supported the inflation decline in LICs.
1 In the average LIC, trade (exports plus imports) has amounted to 58 percent of GDP since
1970, whereas in the average non-LIC EMDE, it has amounted to 83 percent of GDP;
international financial assets and liabilities amounted to 114 percent of GDP in the average LIC
compared with 256 percent of GDP in the average non-LIC EMDE.
FIGURE 1.2.2 Factors supporting falling inflation in LICs

The decline in LIC inflation has been supported by improved policies, greater
openness to trade and finance, and a more benign macroeconomic
environment.
A. Central bank transparency index B. Number of LICs, by exchange rate

regime
C. Government debt D. Exchange rate volatility
E. Financial and trade openness F. Inflation, by country characteristics
Source: World Bank; Haver Analytics; International Monetary Fund; Shambaugh 2004.
Note: Data for 29 low-income countries and 83 other EMDEs. EMDEs = emerging markets and developing
economies; GDP = gross domestic product; LICs = low-income countries.
A.C. Unweighted averages.
B. Exchange rate regime as defined as in Shambaugh (2004).
D. Exchange rate volatility is the cross-country average of the standard deviation of nominal effective
appreciation during each time period.
F. Median year-on-year inflation in LICs during 1998-2017, by country characteristics. “High” indicates
pegged exchange rate regimes (peg) or above-median financial openness, central bank transparency,
and government debt. “Low” indicates floating exchange rate regimes (peg) or below-median financial
openness, central bank transparency, and government debt.
stabilization programs (Mishkin 2000; Bernanke et al. 2001; Mishkin and

Schmidt-Hebbel 2007; Aizenmann, Chinn, and Ito 2011).
1970s. In the wake of two major oil crises—the quadrupling of oil prices in
1973 and the doubling of oil prices in 1979-80—global median inflation tripled
from 4.4 percent in 1970 to 13.7 percent in 1980.3 Some advanced economy
central banks, freed in 1971 from the constraints of the Bretton Woods system
of fixed exchange rates, aimed to support economic activity with monetary
expansion. The elimination of the nominal anchor of fixed exchange rates set off
an inflationary wage-price spiral with weak economic growth (often termed
“stagflation”). Among EMDEs, accommodative monetary policy facilitated a
spillover of inflation from advanced economies (IMF 2011b).
1980s. In advanced economies, monetary policy tightening in the late 1970s and
early 1980s helped rein in inflation, to a median of 3 percent by 1986 from its
peak of 15 percent in 1974, and establish central bank credibility, although often
at the cost of deep recessions. In the United States, for example, short-term
interest rates almost quadrupled between the end of 1976 and mid-1981 (Annex
1.4). In the wake of these interest rate increases, U.S. output contracted by more
than 2 percent between early 1981 and mid-1982. In parts of advanced economy
Europe, central banks responded more strongly and earlier to rising inflation. In
several countries, disinflation was less pronounced than in the United States, but
it was also accompanied by output losses in the early 1980s.
In EMDEs, disinflation was delayed by persistent large fiscal and current
account deficits, often in conjunction with fixed exchange rate regimes,
deteriorating terms of trade for commodity exporters, and political disruptions
(Dornbusch 1986; Edwards 1989). For example, for several decades, Argentina,
Brazil, Chile, Israel, Mexico, Peru, and Uruguay had chronically high
inflation of more than 20 percent for five or more consecutive years. Multiple
stabilization programs were attempted, typically resulting in recessions (Calvo
and Végh 1994).
1990s. In the second half of the 1980s and during the 1990s, many EMDEs
implemented macroeconomic stabilization programs and structural reforms to
improve economic efficiency. These initiatives often included the removal or
easing of foreign exchange market controls, trade liberalization, tighter fiscal
policy, and stronger fiscal and monetary policy frameworks. In EMDEs across
Europe, Central Asia, and South Asia, inflation soared, as previously centrally
planned economies collapsed, and the accompanying price and exchange rate
liberalization released pent-up demand pressures. Subsequent stabilization efforts
3 During the Arab-Israeli War in 1973, global oil prices quadrupled to about $12 per barrel. Around the
time of the Iranian Revolution, oil prices more than doubled in 1979-80 to about $36 per barrel.
were associated with deep output losses. As transition economies exited high
inflation and even hyperinflation during 1989-94, output declined sharply—for
example, cumulatively by 16 percent in Uzbekistan and 75 percent in Georgia—
often amid civil wars and trade embargoes (Fischer, Sahay, and Végh 1996).
Within two years, on average, these economies started growing again. In Latin
America and the Caribbean, renewed stabilization programs that centered
around sound fiscal discipline and greater central bank independence gained
traction and inflation declined (Figure 1.5).
2000s. The disinflation of the 1980s and 1990s paused in the early 2000s in the
run-up to the global financial crisis, partly as a result of rapidly rising energy and
food prices. However, the global financial crisis ushered in a renewed period of
mild disinflation and, in many advanced economies, spells of negative inflation.
Post-crisis, deflation or low inflation was unusually pervasive across advanced
economies: in 2015, inflation was negative in more than half of the advanced
economies and, in 2016, inflation was in the low single digits in three-quarters
of the advanced economies (Figure 1.6). This raised concerns about low
inflation, or possibly even deflation, becoming entrenched in inflation
expectations. To reduce the risk of falling into a deflationary environment,
advanced economy central banks implemented exceptionally accommodative
monetary policy after the global financial crisis, including through
unconventional measures. Chapter 4 explores the interaction between inflation
expectations and inflation in detail. In EMDEs, inflation fell within or below
target ranges in 60 percent of inflation targeting economies (from less than 50
percent in 2007), making room for monetary policy rate cuts to support
economic activity. In 80 percent of EMDEs, inflation in the second quarter
2018 ranged between 0.8 and 6.7 percent (year-on-year), compared with a range
of 3.9 to 23.9 percent in the second quarter of 2008.
Broad-based disinflation. The disinflation over the past three to five decades has
been broad-based across country groups and reflected in headline inflation, core
inflation, and energy and food price inflation. Domestic food and energy prices
constitute a large share of domestic consumption price baskets. Food prices have
been an important contributor to the persistent and steady decline in global
inflation over the past four to five decades, whereas energy prices mainly have
contributed to declining inflation during major oil price plunges.
• Food prices contributed about 5.5 percentage points to the almost 14
percentage point decline in global headline inflation between 1974 and
2017. This was in addition to food prices’ important role in cyclical swings
in headline inflation around this general disinflationary trend. Yet, food CPI
has reflected global food commodity price developments only to a limited
degree. Especially in advanced economies, the estimated pass-through from
international food prices to domestic food prices has been modest (Furceri
et al. 2015) (Figure 1.7).
FIGURE 1.5 Inflation in Latin America and Europe and Central Asia
Median inflation was 14 percent in Latin America during the 1980s and 128 percent in
Eastern Europe and Central Asia during the first half of the 1990s. Eventually, a
combination of macroeconomic stabilization and liberalization policies, against the
backdrop of global disinflation, helped rein in high inflation in these regions.
A. Inflation in LAC countries B. Inflation in ECA countries
C. Share of LAC countries with inflation above D. Share of ECA countries with inflation
20 percent above 20 percent
Source: World Bank.

Note: Inflation refers to year-on-year inflation. ECA = Europe and Central Asia; LAC = Latin America and the Caribbean.
A.C. The grey area denotes the 1980s. LAC includes 32 countries in the region. The orange line in panel C indicates 50
percent of the countries.
B.D. The grey area denotes the 1990s. ECA includes 22 countries in the region. The orange line indicates 50 percent of the
countries.
• Energy prices have contributed to global disinflation only in episodes of

major oil price plunges, most recently in 2014-16. Cumulatively, energy
prices contributed 3.2 percentage points to the almost 14 percentage point
decline in headline global inflation between 1974 and 2017. Energy price
inflation has clearly fallen from its 1970s peaks, and it was broadly stable
throughout the 1990s and 2000s.
Subsidies, offsetting exchange rate fluctuations, and a growing domestic services
content of cost drove a wedge between domestic food and energy prices and
global commodity prices. Domestic energy price inflation was even less
homogeneous across EMDEs than domestic food inflation, possibly reflecting a
wide variety of fuel subsidy schemes. Domestic food and energy prices have a
sizable tradable component, because many countries import energy and food
products, but the share of nontradable domestic services (such as logistics and
FIGURE 1.6 Distribution of inflation

Post-crisis inflation has been unusually homogeneous and low in advanced economies and
EMDEs.
A. CPI inflation distribution: 1970-97 B. CPI inflation distribution: 2010-17
C. Inflation distribution: Advanced economies D. Inflation distribution: EMDEs
E. Number of advanced economies, by F. Number of EMDEs, by deviation from

deviation from inflation target inflation target
Source: World Bank.

Note: CPI = consumer price index; EMDEs = emerging market and developing economies; LICs = low-income countries.
A.-D. Inflation refers to quarter-on-quarter annualized inflation.
C.D. Sample includes 27 advanced economies and 50 EMDEs.
E.F. Sample includes 17 advanced economies and 27 EMDEs. “Within” indicates the number of countries with inflation
within target ranges or within ±1 percentage point of the inflation target for those countries that do not announce a range
or below the inflation target for those countries that announce an inflation target ceiling.
FIGURE 1.7 Components of inflation

The disinflation over the past three decades was broad-based in its components, reflected
in headline inflation, core inflation, and food price inflation, and cutting across advanced
economies and EMDEs.
A. Median food inflation in EMDEs, by region B. Median energy inflation in EMDEs, by

region
C. Median food price inflation and global food D. Median energy price inflation and global
commodity price inflation energy commodity price inflation
E. Correlation of domestic inflation cycle with F. Correlation of inflation cycle with global
global commodity price cycle commodity price cycle
Source: Pink Sheet, World Bank.

Note: CPI = consumer price index; EMDEs = emerging market and developing economies; GDP = gross domestic product.
A.B. Weights are food and energy weights used to calculate CPI. Weights are weights of food (A) and energy (B) in CPI
baskets.
Inflation refers to year-on- year inflation. EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin
America and the Caribbean; MNA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa.
C.D. Energy and food commodity price inflation from the World Bank’s Pink Sheet of commodity prices.
Correlation of detrended headline CPI and GDP deflator with detrended global energy and food price inflation. Detrended
using the Hodrick-Prescott filter.
Correlation between detrended domestic headline, energy, and food price inflation with detrended global energy and food
price inflation. Detrended using the Hodrick-Prescott filter.
retail) in domestic food and energy prices is growing. As a result, the correlation
of domestic food and energy prices with domestic headline inflation has
increased (Furceri et al. 2015). Chapter 6 examines in greater depth the
contribution of policies to food prices.
Declining inflation volatility. Trend disinflation has been accompanied by a
trend decline in inflation volatility across all EMDE regions, measures of
inflation, and inflation components. Inflation volatility is measured as the time-
varying volatility of trend and cyclical inflation (Stock and Watson 2016). CPI
inflation volatility has fallen in advanced economies and EMDEs (Figure 1.8).
Although most of the volatility decline has reflected declining volatility of the
trend component of inflation, which approximates the volatility of core
inflation, declining cyclical inflation, which captures temporary shocks, has also
contributed. Declining trend inflation volatility in part reflects the lower
volatility of structural economic shocks. The significant decline in
macroeconomic volatility in advanced economies between the mid-1980s and
the global financial crisis has been labeled the “Great Moderation.”4
Differences in inflation volatility among the major groups of economies persist
but have narrowed somewhat. EMDEs, especially LICs, have continued to
experience higher inflation volatility than advanced economies. Partly because of
the inflation swings around economic liberalization in the early 1990s and partly
because of domestic conflict, inflation volatility in Europe and Central Asia,
South Asia, and Sub-Saharan Africa was high until 1997, but since then it has
declined sharply in Europe and Central Asia and Sub-Saharan Africa. In South
Asia, it remains elevated because of the high volatility of food prices, which
account for a large share of the region’s CPI basket (46 percent).
Declining inflation expectations. Well-anchored inflation expectations can
ensure that trend inflation remains unaffected by temporary shocks. In both
advanced economies and EMDEs, long-term (five-year-ahead) inflation
expectations have declined over the past three decades. In advanced economies,
inflation expectations have remained stable at about 2 percent per year since
2000, after declining rapidly in the 1990s, with little cross-country variation
(Figure 1.9). In EMDEs, inflation expectations decreased markedly in the
second half of the 1990s, but then trended up during 2005-14 before retreating
somewhat over the following three years. The increase in inflation expectations
during 2005-14 was somewhat more pronounced in countries with low central
bank transparency than in those with high transparency. Throughout the past
4 Stock and Watson (2003); Bernanke (2004); Clark (2009). In the United States, the Great
Moderation has been attributed to smaller variance of shocks and positive and stable technological shocks
(“good luck”), new inventory processes and labor supply shocks that reduced wage and marginal cost
pressures (“structural change”), and more stabilizing monetary policy (“good policies”) (Fernández-
Villaverde, Guerrón-Quintana, and Rubio-Ramírez 2010).
FIGURE 1.8 Global inflation volatility

Trend disinflation was accompanied by a trend decline in inflation volatility that cut across
EMDE regions, measures of inflation, and inflation components.
A. Median CPI and PPI inflation volatility B. Energy, PPI, and global oil price volatility
C. Inflation volatility, by country group D. Inflation volatility, by region
E. Inflation volatility, by region F. Median food and energy inflation volatility,

by country group
Source: Pink Sheet, World Bank.

Note: Volatility of cyclical components of inflation, as estimated by Stock and Watson (2016). Trend inflation is defined as
the part of inflation that follows a permanent stochastic trend; cyclical inflation is a serially uncorrelated transitory
component of inflation. Inflation refers to year-on-year inflation. AEs = advanced economies; CPI = consumer price index;
EMDEs = emerging market and developing economies; GDP = gross domestic product; LICs = low-income countries;
A. Balanced sample of 28 countries. The latest data point is 2017:1.
C. The sample includes 27 advanced economies, 44 EMDEs, and 10 LICs.
D.E. EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean;
MNA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa.
F. Volatility defined as the cross-country median of the standard deviation. Weights are the weight of food and energy
in CPI consumption baskets.
FIGURE 1.9 Global inflation expectations
In advanced economies, inflation expectations have been broadly stable since the
mid-2000s, following a decline during the 1990s. In EMDEs, inflation expectations fell
markedly during the late 1990s but then rose during 2005-14 before retreating again.
A. Inflation expectations in advanced B. Inflation expectations in EMDEs

economies (5-year-ahead forecasts) (5-year-ahead forecasts)
C. Share of countries with declines in D. Five-year-ahead inflation expectations in

5-year-ahead inflation expectations, 1995-2018 EMDEs, by central bank transparency
Source: Consensus Economics, International Monetary Fund, Dincer and Eichengreen 2014, World Bank.
A.B. Solid lines indicate the median and dotted lines indicate the interquartile range.
C. The orange line indicates 50 percent of the countries.
D. High (low) transparency countries are defined as those with central bank transparency above the 75th (below the 25th)
percentile of EMDEs.
three decades, cross-country variation in inflation expectations across EMDEs

exceeded the variation across advanced economies. Chapter 4 discusses the
drivers of inflation expectations in detail.
Historical precedent. The current low and stable global inflation environment
resembles inflation during the Bretton Woods fixed exchange rate system in the
post-war period until 1971 and during the gold standard of the early 1900s—
both of which provided nominal anchors to countries across the globe (Figure
1.10). In all three periods, global inflation was below 5 percent for an extended
time span (7-19 years). The loss of a nominal anchor at the end of the earlier
regimes was followed by a period of high inflation until the widespread
implementation of inflation targeting and strengthening central bank credibility
helped anchor expectations again (Bernanke et al. 2001; Rose 2007; Beyer et al.
2009). However, the post-crisis period of extremely low global inflation differs
from the Bretton Woods fixed exchange rate regimes and the gold standard in its
lower inflation volatility.
Long-term correlates of inflation

Several structural changes have accompanied global disinflation over the past
four to five decades. On average, inflation has declined more in countries that
have participated more in global value chains, have moved to inflation targeting
regimes, have more independent and transparent central banks, and have more
open capital accounts.
Inflation is often affected by unexpected short-term shocks. But, over time,
wages and prices adjust and inflation reverts to its long-term trend. This trend is
determined by the monetary and fiscal policies, institutional frameworks, and
structural features of an economy.5
The Phillips curve summarizes the response of inflation to unexpected short-
term shocks. Demand-side inflationary pressures include monetary and fiscal
policy as well as asset price swings that can affect consumption through wealth
effects. Supply-side factors include raw material (energy and food) price shocks,
wage growth, and currency depreciation. The role of these drivers of short-term
fluctuations in inflation is discussed in detail in Chapters 2 and 3.
Empirically, variants of the Phillips curve have been used to model inflation
dynamics.6 Wage Phillips curve models link wage growth to labor market slack
(or broader economic slack) and wage bargaining power (Phillips 1958; Gali
2010; Kahn 1980). Price Phillips curve models link price inflation to unit labor
cost or, more generally, labor market slack and material cost (Bhattarai 2016;
Blanchard and Gali 2008). Open economy Phillips curve models include external
cost-push factors such as foreign inflation, commodity prices, import prices, and
exchange rates, and external demand-pull factors represented by global output
gaps (Draghi 2015; Abbas, Bhattacharya, and Pasquale 2016).
Long-term structural factors can affect how inflation and inflation expectations
respond to short-term shocks and the level at which inflation settles absent such
5 Monetary policy can cause changes in real activity if inflation expectations are unchanged or adapt
with a lag to monetary policy changes (Taylor 1980; Rotemberg 1982; Calvo 1983) or if the wage and
price settings adapt with a lag to monetary policy changes (Sims and Zha 1998).
6 Evidence for a Phillips curve relationship is found by Batini, Jackson, and Nickell (2005);
Rumler (2007); Osorio and Unsal (2013); Ciccarelli and Mojon (2010); Eickmeier and Pijnenburg
(2013); Gamber and Hung (2001); Guerrieri, Gust, and López-Salido (2010); Bianchi and Civelli
(2015); Ihrig et al. (2010); Milani (2012); Zhang (2015); and Nguyen et. al. (2017). Evidence that the
link between inflation and output gaps has declined is found by Roberts (2006); Mishkin (2007); and
Szafranek (2017).
FIGURE 1.10 Historical perspective

The current period of low and stable inflation resembles inflation during the Bretton Woods
system of fixed exchange rates in the 1950s and 1960s and during the gold standard in the
early 1900s—both systems provided nominal anchors.
A. Inflation distribution B. Inflation and inflation volatility
C. Inflation in 1900-13, 1944-71, and 2010-17 D. Inflation volatility in 1900-13, 1944-71, and
2010-17
Source: World Bank.

Note: OPEC = Organization of the Petroleum Exporting Countries
A.B. Based on a sample of 26 countries.
B. A = gold standard and stability (1880-1913); B = World War I and high inflation (1914-18); C = post–World War I depre-
sion and deflation (1920-22); D = Great Depression (1929-33); E = World War II, monetary controls and post-war inflation
(1945-49); E and F = Bretton Woods system of fixed exchange rates (1944-71); F = floating exchange rates and oil shocks
(OPEC, 1971-79); G = introduction of inflation targeting (1990-2000); H = global financial crisis.
B.D. Volatility is defined as the rolling standard deviation.
C.D. Cross-country average and standard deviation of annual average inflation. Orange lines denote 1900-2017 average.
shocks. Chapter 4 documents how the presence of inflation targeting regimes

has helped better anchor inflation expectations. Among EMDEs, other
supporting factors have included greater central bank credibility, greater trade
openness, and lower government debt.
These long-term correlates of inflation are the focus of the remainder of this
chapter. They have changed significantly over the past four to five decades.
Global trade and financial flows have more than doubled since 1970, as many
economies have liberalized trade regimes and capital accounts. Many economies
have adopted inflation targeting and moved away from fixed exchange rate
regimes while strengthening fiscal frameworks and liberalizing labor markets.
In EMDEs, similar structural changes have taken place as in advanced
economies, although somewhat later and, in some respects, to a lesser degree.
For example, by 1998, when Poland became the first EMDE to adopt a full
inflation targeting regime, more than one-quarter of advanced economies had
already switched to inflation targeting. During 2000-14, central bank
independence and transparency improved in the median advanced economy and
EMDE, but the increase was considerably more pronounced (2.25 index points)
in advanced economies than in EMDEs (1 index point). And central bank
independence and transparency in the median EMDE remains at only one-third
the level in the median advanced economy. Similarly, whereas the increase in
trade openness in EMDEs occurred broadly in step with advanced economies,
the increase in financial integration during the 1980s and 1990s was
considerably more pronounced in advanced economies than in EMDEs.
Trends in long-term drivers have contributed to global disinflation. On average,
inflation has been lower and declined by more in countries that have been more
open to trade, had (or switched to) inflation targeting regimes, had more
independent and transparent central banks, and had more open capital accounts.
This section presents these correlations in descriptive statistics and, more
formally, in regression analysis and frames them in the context of the literature.
Trade integration
Literature. Trade integration—increased openness to international trade—is
typically accompanied by higher shares of imports in consumption and
production and lower prices (compared with a closed economy), owing to
competitive pressures from foreign producers.7 Increasing trade integration may
also account for the rising international comovement in inflation, as discussed in
Chapter 2. The impact on the responsiveness of inflation to domestic economic
slack (that is, the slope of the Phillips curve) is ambiguous: greater foreign
competition reduces firms’ ability to raise prices and wages in response to
domestic demand pressures, hence flattening the Phillips curve; alternatively, if
greater foreign participation in domestic markets increases competitive pressures,
it could encourage a faster response to demand pressures, hence steepening the
Phillips curve.8 Greater trade openness appears to be associated with lower
inflation volatility.9
7 Yellen (2006); Romer (1993); Terra (1998); Lane (1997); Al Naseer, Sachsida, and Mário (2009);
Vuletin and Zhu (2011). In particular, the increased trade integration of China into the global trading
system, since its World Trade Organization accession in 2001, may have reduced inflation globally
(Frankel 2007; IMF 2016; Eickmeier and Kühnlenz 2013). Meanwhile, the rising role of services, which
are less subject to external shocks, may have helped reduce inflation volatility, but the increasing
productivity gap between tradables and nontradables with relatively subdued wage growth might have
lifted inflation rates (Roncaglia de Carvalho 2014; Lünnemann and Mathä 2005).
8 Borio and Filardo (2007), Iakova (2007), Kohn (2006), Razîn and Binyamini (2007), and Yellen
(2006) argue for flattening Phillips curves; Sbordone (2007) and Benigno and Faia (2016) argue for
steepening Phillips curves.
9 Granato, Lo, and Wong (2006); Bowdler and Malik (2005).
Trade in intermediate goods—a proxy for integration into global value chains—
may be more informative about international competitive pressures on inflation
than trade in final goods (Lombardo and Ravenna 2014; Burstein, Kurz, and
Tesar 2008). Global value chain integration has facilitated the adoption of “just-
in-time” inventory practices and associated with lower inflation volatility
(Hakkio 2013). It has also been associated with a greater role of global factors in
domestic inflation and greater international synchronization of inflation (Auer,
Borio, and Filardo 2017).
Trends in trade integration. Over the past four to five decades, global trade
openness (the sum of exports and imports relative to GDP) has increased by
more than half—to 74 percent of global GDP in 2016, from almost 50 percent
of global GDP in 1970. In the median EMDE, trade openness increased from
almost 50 percent of GDP in 1970 to 72 percent of GDP in 2016. Similarly, in
the median advanced economy, trade openness increased from 47 percent of
GDP in 1970 to 80 percent of GDP in 2016. The expansion of trade by
EMDEs has been accompanied by rapidly rising trade integration among
EMDEs, with China becoming the largest trading partner for one-fifth of the
countries in this group (World Bank 2016). The most rapid expansion of trade
occurred in the 1990s and early 2000s (Figure 1.11).
Since the 1990s, trade integration has fostered the creation and expansion of
global value chains, especially among advanced economies. As a result, the share
of foreign value added embodied in exports in advanced economies (backward
integration) increased from 10 percent in the 1970s to about 30 percent on
average during 2000-16. Although less rapidly and somewhat later, the share of
foreign value added in domestic exports in EMDEs also increased in the 1990s
and 2000s, to 10 percent in 2016, from 1.5 percent in 1990.
Correlation with inflation. Inflation levels and volatility have typically been
lower in economies and time periods with greater trade openness. The full
sample was split into country-year pairs in the bottom and top quartiles of trade-
to-GDP ratios and shares of foreign value added in exports. Median inflation
was 4 percentage points lower and half as volatile in the top quartile than in the
bottom quartile of trade-to-GDP ratios. Inflation was also more than 3
percentage points lower and one-fifth as volatile in the top quartile than in the
bottom quartile of global value chain participation.
A bivariate panel regression suggests that, in countries where trade openness

increased by 10 percentage points of GDP over the past four decades—about the
median in the sample—inflation declined (although insignificantly) by 0.2
percentage point more than average over the same period. This relationship was
even weaker among EMDEs (Tables A.1.3.1 and A.1.3.2, Annex 1.3).
FIGURE 1.11 Trade integration and inflation

Since the 1970s, global trade and global value chain integration has deepened
significantly. Greater trade openness and deeper supply chain integration have been
associated with lower inflation and inflation volatility and a sharper decline in inflation since
the 1970s, especially in EMDEs.
A. Trade in advanced economies and EMDEs B. Participation in global value chains
C. Inflation, by trade openness and global D. Correlation between disinflation and

value chain participation changes in trade openness (1980s-2010s)
Source: IMF Direction of Trade Statistics; OECD; World Bank World Development Indicators; WTO.
Note: Inflation volatility is defined as volatility in cyclical inflation, detrended using Stock and Watson’s (2016) methodology.
Inflation refers to year-on-year inflation. EMDEs = emerging market and developing economies; GDP = gross domestic
product; GVC = global value chain.
A. Median trade-to-GDP ratio in EMDEs, advanced economies, and globally.
B.C.D. Backward participation in global value chains is a measure of how much foreign value added is embodied in a
country’s exports, as a percentage of total gross exports. Data are available for 59 countries for 1995, 2000, 2005, and
2008-11. Forward participation in global value chains is a measure of how much a country’s value added is embodied in
foreign exports, as a percentage of total gross exports. Data are available for 59 countries for 1995, 2000, 2005, and 2008-
11. Data are available for a maximum of 166 countries, but with uneven coverage; the data are available for 1988-2016 for
137 countries (World Bank 2017a, 2017b).
C. Columns indicate median inflation in countries with global value chain integration and trade openness in the top quartile.
Horizontal bars indicate median inflation in countries with trade openness and global value chain integration in the bottom
quartile. The difference in inflation levels and volatility (except for volatility in advanced economies) between high and low
trade openness and GVC participation is statistically significant at the 1 percent level.
D. Blue bars show the coefficient estimates from bivariate panel regressions of changes (between the decadal averages of
the 1980s and 2010s) in inflation on changes in trade openness over the same period (see Tables A.1.3.1. and A.1.3.2,
Annex 1.3). Vertical lines are ±1.64 standard errors of the coefficient estimate
Financial openness
Literature. In theory, financial openness could raise or depress inflation
volatility. If capital flows help smooth fluctuations in consumption in a
financially open economy, they can moderate domestic demand swings that
might otherwise generate inflationary or disinflationary pressures. This would
reduce inflation volatility. Conversely, procyclical capital inflows could

themselves generate larger domestic demand swings and cause greater volatility
in output and inflation.
Empirically, greater capital account openness has been associated with lower
inflation. Multiple studies have found in large cross-sections of countries that
greater capital account openness has been accompanied by lower average
inflation (Badinger 2009; Gruben and McLeod 2002; Aizenman, Chinn, and
Ito 2008). This pattern has been attributed to a stronger anti-inflation bias of
central banks amid sharper trade-offs between output growth and inflation
(Badinger 2009), or to a greater interest rate elasticity of money demand
(Gruben and McLeod 2002).
Trends in financial openness. Advanced economies liberalized their capital
accounts almost fully between 1970 and 2000, whereas capital account
liberalization in EMDEs has proceeded at a more guarded pace (Figure 1.12). In
the median advanced economy, the Chinn and Ito (2017) index of capital
account openness, which ranges between 0 and 1, increased to 0.9 in 2017 from
0.4 in 1970. In the median EMDE, this index temporarily increased from 0.2 to
0.4 in the mid-1990s, but then declined again as restrictions were reimposed in
the aftermath of the Asian crisis. Similarly, capital account openness in EMDEs
increased again in the mid-2000s until the global financial crisis but narrowed
again thereafter. Since 1970, financial integration has surged: in the median
EMDE, as in the median advanced economy, the share of international assets
and liabilities has more than tripled, to 121 percent of GDP in 2017 (although
they remain only one-quarter the level in advanced economies).
Correlation with inflation. Capital account openness has been associated with
lower inflation and inflation volatility. The country-year pairs with the top
quartile of most open capital accounts had, on average, 12 percentage points (10
percentage points for EMDEs) lower inflation, and lower volatility, than the
bottom quartile of country-year pairs with the least open capital accounts.
Similarly, in countries and years with international assets and liabilities relative
to GDP in the top quartile of the sample, inflation was less than half (and
volatility was one-fifth) its level in those in the bottom quartile. The difference
in inflation levels may reflect the disinflation in advanced economies after their
capital accounts were largely liberalized. In EMDEs, capital account openness
has also been associated with lower inflation, but this relationship has been less
pronounced than in advanced economies.
Again, the panel regression suggests that an increase of 0.5 point in the capital
account openness index over the past four decades was associated, on average
globally, with a 4.7 percentage point stronger disinflation and, among EMDEs,
a 4.0 percentage point stronger disinflation (Tables A.1.3.1 and A.1.3.2, Annex
FIGURE 1.12 Capital account openness and inflation

Over the past five decades, advanced economies have liberalized their capital accounts
and, at a slower pace, EMDEs have partially liberalized their capital accounts. Greater
capital account openness has been associated with lower and more stable inflation.
A. Index of capital account openness B. International assets and liabilities
C. Inflation, by capital account openness D. Inflation, by international assets and

liabilities
E. Correlation between disinflation and F. Correlation between disinflation and

changes in capital account openness index changes in international assets and liabilities
(1980s-2010s) (1980s-2010s)
Source: IMF Direction of Trade Statistics; World Bank World Development Indicators.
Note: Capital account openness is defined as in Chinn and Ito (2006). The index ranges from 0 (closed capital account)
to 1 (open capital account). Inflation refers to year-on-year inflation. AEs = advanced economies; EMDEs = emerging
market and developing economies; GDP = gross domestic product.
A.B. Medians (A) or unweighted averages (B).
C.D. Columns indicate the median inflation levels and inflation volatility in country-year pairs with a Chinn-Ito Index (C) or a
sum of international assets and liabilities relative to GDP (D) in the top quartile over 173 economies (C) or 175 economies
(D) during 1970-2017. Horizontal bars indicate countries in the bottom quartile. Financial integration is defined as the sum
of international assets and liabilities as a percentage of GDP. The difference in inflation levels and volatility between high
and low capital account openness and financial assets and liabilities is statistically significant at the 1 percent level.
E.F. Blue bars show the coefficient estimates from bivariate panel regressions of change in average annual inflation
between the 1980s and the 2010s and the change in the decadal average Chinn-Ito index (E) or the change in the sum of
international assets and liabilities relative to GDP (F) over the same period (Tables A.1.3.1 and A.1.3.2, Annex 1.3). Vertical
lines are ±1.64 standard errors of the coefficient estimate.
1.3). Such an increase in capital account openness would be approximately in

line with the top quartile for advanced economies (0.58 point increase) and the
top decile in EMDEs (0.53 point increase) over the past four decades. Similarly,
in EMDEs, an increase in international assets and liabilities of 30 percentage
points of GDP—the median increase between the 1980s and 2010s—was
associated with a statistically significant 1.5 percentage point stronger
disinflation over the past four decades (Tables A.1.3.1 and A.1.3.2, Annex 1.3).
Monetary policy frameworks and exchange rate regimes

Literature. Pegged exchange rate regimes and inflation targeting monetary policy
regimes—if supported by other policies—can provide the nominal anchor for
inflation expectations that can help ensure low and stable inflation (Bernanke
and Mishkin 1997; Fischer 2001; Mussa et al. 2000). Particularly for countries
with weak institutions, a formal pegged exchange rate regime can signal a
commitment to monetary and fiscal policy discipline. Implementation of such a
strategy may not be straightforward, however. The level of the exchange rate at
which the domestic currency is pegged is especially important if domestic
inflation exceeds inflation in the country whose currency forms the peg: the
domestic economy will then continue losing international competitiveness until
the inflation rates converge. Even after the inflation rates have converged, the
domestic economy may be burdened by the loss of competitiveness that has
occurred since the peg was established. These issues may give rise to pressures
that test the viability of the peg.
For countries with sufficiently strong institutions to implement credible
inflation targeting regimes, this can anchor expectations at the inflation target.
Thus, a pegged exchange rate or inflation targeting monetary policy regime can
ensure that temporary shocks to inflation—caused, for example, by exchange
rate swings or food price spikes—remain temporary, without being passed
through to trend or core inflation.
Pegged exchange rate regimes have been associated with lower inflation than have
other exchange rate regimes (Bleaney and Fielding 2002; Ghosh et al. 1997). In
transition economies during the 1990s and 2000s, the switch to a pegged
exchange rate regime was associated with disinflation (Domaç and Yuzefovichî
2003). In some EMDEs, the lower inflation achieved by pegging the exchange
rate has been at the cost of higher volatility of output growth and inflation
(Bleaney and Fielding 2002), whereas in broader samples during an earlier
period, pegged exchange rate regimes were associated with more stable inflation
(Ghosh et al. 1997; Moreno 2001). That said, any difference between inflation
and its volatility in pegged and more flexible exchange rate regimes may partly
reflect the highly diverse nature of more flexible regimes, which include
countries with a wide range of institutional arrangements (Rose 2011).
In advanced economies, inflation targeting regimes have been associated with

limited lasting effects on inflation levels and volatility but with lower inflation
persistence. In seven advanced economies, the shift to inflation targeting in the
1990s was not always accompanied by significantly lower inflation rates or
inflation volatility (Ball and Sheridan 2005; Bernanke et al. 2001; Lin and Ye
2007). Among a broader and more recent sample of advanced economies, the
adoption of inflation targeting was associated with lower inflation within two
years but at the cost of higher inflation volatility (Fang, Miller, and Lee 2012;
Levin, Natalucci, and Piger 2004). In addition, inflation targeting was
accompanied by a more modest response of inflation to exchange rate and oil
price shocks (Mishkin and Schmidt-Hebbel 2007). Several studies have
attributed declining inflation persistence in advanced economies in the early
2000s to inflation targeting or its introduction (Benati 2008; Canarella and
Miller 2017). Widespread adoption of inflation targeting regimes has been
shown to help promote global economic stability (Rose 2007; Taylor 2014).
In EMDEs, in contrast to advanced economies, inflation targeting regimes have
been associated with significantly lower and more stable inflation (Fang, Miller,
and Lee 2012). The introduction of such regimes has been associated with
significantly larger drops in inflation than in other EMDEs (Gonçalves and
Salles 2008). This reduction of inflation has partly been attributed to better
anchoring of inflation expectations and, in some EMDEs, lower inflation
persistence (Batini and Laxton 2007; Canarella and Miller 2017; Gerlach and
Tillmann 2012). That said, some studies have found that the effectiveness of
inflation targeting in lowering inflation in EMDEs varies widely by country
characteristics, including fiscal positions and the length of time since the
adoption of inflation targeting (Mishkin 2000, 2008a; Lin and Ye 2009).
Trends in exchange rate and inflation targeting regimes. Over the past four to
five decades, inflation targeting monetary policy regimes have become
widespread, while pegged exchange rate regimes, which were predominant up to
the 1970s, have receded. In 1990, New Zealand was the only economy
implementing inflation targeting. A growing number of advanced economies
and EMDEs have subsequently adopted inflation targeting regimes, in an effort
to replace the nominal anchor offered by pegged exchange rates. The number of
inflation targeting central banks increased to 14 by 2000 and 35 by 2017
(Figures 1.6 and 1.13), and the share of EMDEs relying on pegged exchange
rate regimes fell by one-third between 1970 (84 percent of countries) and 2017
(54 percent). Many inflation targeting central banks, especially in EMDEs, have
brought inflation within target ranges while also lowering the midpoints of
target ranges (Figures 1.6 and 1.13). The transition from fixed to floating
exchange rate regimes was smoother in some countries (for example, Chile) than
in others (for example, Brazil) where it was followed by exchange rate crises
(Annex 4.5).
Correlation with inflation. Among countries with pegged exchange rate regimes
or inflation targeting monetary policy frameworks, inflation was, on average, 3-4
percentage points lower than under other exchange rate and monetary policy
regimes (Figure 1.14). This was most evident among EMDEs: fixed exchange
rate regimes and inflation targeting regimes were associated with 3-4 percentage
points lower inflation, whereas in advanced economies, the difference was less
than 2 percentage points. Compared with other exchange rate and monetary
policy regimes, inflation targeting regimes were also associated with lower
inflation volatility, while pegged exchange rate regimes were not.
A panel regression suggests that, over the past four decades, a switch to an
inflation targeting regime tended to be accompanied by 6.5 percentage points
more disinflation (9.1 percentage points more for EMDEs) than average (Table
A.1.3.1, Annex 1.3). One-quarter of the advanced economies and one-tenth of
the EMDEs in the sample made the switch to an inflation targeting regime over
this period. A switch to a pegged exchange rate regime had no statistically
significant impact among EMDEs.
Central bank independence and transparency
Literature. A stability-oriented monetary policy and exchange rate regime can be

bolstered by central bank independence and transparency. A more independent
central bank is in a more credible position to achieve monetary policy targets,
even at the expense of other economic policy targets. More transparent central
bank operations, strategy, and communications can safeguard the legitimacy of
the central bank, enhance public understanding of and confidence in sound
monetary policy, promote informed discussion among market participants and
the broader public, and more effectively guide and stabilize inflation
expectations.
Empirically, central bank transparency has been found to help anchor inflation
expectations in advanced economies (van der Cruijsen and Demertzis 2007;
Demertzis and Hallett 2007). In these economies, central bank transparency has
reduced inflation expectations and, therefore, inflation and inflation uncertainty
(Weber 2016; Siklos 2003; Demertzis and Hallett 2007). More More narrowly,
among 87 advanced and emerging market economies, greater detail in central
bank forecasts has been accompanied by lower inflation, except in countries
with exchange rate targeting regimes (Chortareas, Stasavage, and Sterne 2001).
That said, Cecchetti and Krause (2002) find that in 63 advanced and emerging
market economies, a long history of low inflation is more important
for macroeconomic stability than any particular institutional arrangement.
The impact on inflation persistence remains ambiguous (Dincer and
Eichengreen 2010).
FIGURE 1.13 Inflation targeting regime and inflation

Over the past five decades, inflation targeting monetary policy regimes have become
widespread, while pegged exchange rate regimes, which were predominant in the 1970s,
have receded.
A. Share of countries with pegged exchange B. Countries with inflation targeting regimes
rate regimes
C. Inflation targets D. Number of advanced economies and

EMDEs meeting inflation targets
Source: Caceres, Carrière-Swallow, and Gruss 2016; International Monetary Fund; Shambaugh 2004; World Bank.
Note: Pegged exchange rates are defined, based on a de facto classification, as exchange rates fluctuating within a +/-2
percent band or at most, one one-time devaluation over the preceding 11-month period relative to a country-specific refer-
ence currency (Shambaugh 2004). Inflation targeting regimes are defined as in Caceres, Carrière-Swallow, and Gruss
(2016) and the IMF Annual Report on Exchange Arrangements and Exchange Restrictions. EMDEs = emerging market
and developing economies.
B. Bars indicate the number of countries with inflation targeting regimes in which inflation is within or below the target range
or below the point target (“Within or below target”) or above the target range or point target (“Above target”).
C. Median inflation target among 34 advanced economies and 141 EMDEs. Dashed lines represent interquartile ranges of
upper and lower bounds.
D. Number of advanced economies and EMDEs meeting their inflation targets, 2000-17.
Trends in central bank independence and transparency. Central bank

independence and transparency have increased considerably over the past two
decades, especially in EMDEs (Figure 1.15). In the median EMDE, the index of
central bank independence and transparency increased more than one-and-a-
half-fold since 1990, to 5.4 in 2014. Notably, the turnover rate of heads of
central banks fell by one-third among EMDEs between 1990 and 2016, with
the most widespread improvements in East Asia and Pacific and Europe and
Central Asia.10
10 For sources and definitions of data on turnover rates, see the Appendix.
FIGURE 1.14 Monetary framework, exchange rate regime, and

inflation
Among countries with pegged exchange rate regimes or inflation targeting monetary policy
frameworks, inflation was lower and less volatile and has declined more strongly since the
1970s than under other exchange rate and monetary policy regimes.
A. Inflation, by monetary policy and exchange B. Difference in disinflation associated with

rate regime switch in exchange rate regime and monetary
policy regime (1980s-2010s)
Source: Caceres, Carrière-Swallow, and Gruss 2016; Shambaugh 2016; World Bank World Development Indicators;
World Bank.
Note: Pegged exchange rates are defined, based on a de facto classification, as exchange rates fluctuating within
a ±2 percent band or at most one one-time devaluation over the preceding 11-month period relative to a country-specific
reference currency (Shambaugh 2004). Inflation targeting regimes (“IT”) are defined as in Caceres, Carrière-Swallow, and
Gruss (2016) and the IMF Annual Report on Exchange Arrangements and Exchange Restrictions. Inflation refers to year-
on-year inflation. AEs = advanced economies; EMDEs = emerging market and developing economies; EX = exchange rate
regime; IT = inflation targeting regime.
A. Columns show median inflation in countries with pegged or inflation targeting monetary policy regimes during 1970-
2017. Horizontal bars indicate median inflation in countries without pegged or inflation targeting monetary policy regimes
during the same period. The difference in inflation levels and volatility between inflation targeting and other regimes is
statistically significant at the 1 percent level.
B. Blue bars show the coefficient estimates from bivariate panel regressions of changes (between 1980-89 and 2010-17)
in inflation on a switch (over the same period) to an inflation targeting regime or pegged exchange rate regime
(Tables A.1.3.1 and A.1.3.2, Annex 1.3). Vertical lines are ±1.64 standard errors of the coefficient estimate. The difference
in inflation levels and volatility between high and low central bank independence and transparency is statistically significant
at the 1 percent level.
Correlation with inflation. On average, country-year pairs ranking in the top

quartile of the index of central bank independence and transparency have had 4
percentage points lower inflation (3 percentage points for EMDEs) and one-half
to one-fifth of the inflation volatility of country-year pairs ranked in the bottom
quartile of the sample. These differences are most pronounced in EMDEs. A
panel regression suggests that a one point improvement in the Dincer and
Eichengreen (2014) central bank independence and transparency index—the
median improvement in EMDEs and advanced economies over the past four
decades—was accompanied by 1-1.2 percentage points stronger than average
disinflation over the same period.
Fiscal frameworks
Literature. When options for private domestic and foreign borrowing by

governments are limited or costly, central banks may be compelled to finance
fiscal deficits. Unless such deficit financing is accompanied by crowding out of

private credit, money supply and inflation will rise, exchange rate pressures will
build, and the central bank’s room to achieve monetary policy goals will be
restricted (Sargent and Wallace 1981).
Empirically, the evidence for such a link between fiscal deficits and inflation has
been inconclusive, but it appears to be stronger for countries with preexisting
high inflation or during high-inflation episodes. In a large sample of countries,
wider fiscal deficits have been associated with higher inflation, especially
in countries in which inflation was high to begin with (Fischer, Sahay, and Végh
2002) or where money supply was large relative to GDP (Catao and Terrones
2001). Similarly, rising debt has been associated with higher inflation
in countries with already-high initial debt levels (Kwon, McFarlane, and
Robinson 2009; Bleaney 1999). Turkey in the late 1980s is an example of a
country in which the monetization of large fiscal deficits resulted in high
inflation (Rodrik 1990).
Trends in fiscal frameworks. Over the past four to five decades, trends in
government debt have diverged between advanced economies and EMDEs
(Figure 1.16). Government debt steadily increased in advanced economies to 68
percent of GDP, on average, in 2017. In contrast, in EMDEs, government debt
fell to 49 percent of GDP in 2017, well below its peak of 72 percent in 1994,
despite a post-crisis reversal of the earlier decline. In EMDEs, lower government
debt may have been associated with reduced financing needs, including from
central banks. Meanwhile, the number of countries with fiscal rules increased to
88 (including 49 EMDEs) in 2017, from six in 1985 (including two EMDEs)
when the data series starts.
Correlation with inflation. There has been little difference, on average, between
inflation in countries with government debt-to-GDP ratios in the top and
bottom quartiles of the sample. However, countries with government debt in
the lowest quartile have had considerably lower inflation volatility. Reflecting
the wide range of correlations between inflation and government debt, the panel
regression also finds no statistically significant relationship between the initial
level of government debt and disinflation over the past four decades (Table
A.1.3.1, Annex 1.3). Although low government debt per se was not
unambiguously associated with stronger disinflation, inflation has been lower in
countries with fiscal rules than in those without them (Figure 1.16).
Labor and product markets

Literature. In 40 advanced and emerging market countries during the 1970s,
wage indexation was associated with a greater impact of shocks on inflation
(Fischer 1983). Such wage indexing also affects inflation persistence: widespread
FIGURE 1.15 Central bank transparency and inflation

Over the past three decades, central banks have become more independent and
transparent. Greater central bank independence and transparency has been associated
with lower and more stable inflation.
A. Countries with improving central bank B. Countries with improving central bank
independence and transparency, by region independence and transparency, by country
(1998-2014) group (1998-2014)
C. Inflation, by central bank independence D. Correlation between disinflation

and transparency (1980s-2010s) and changes in central
bank independence and transparency
Source: Dincer and Eichengreen 2014; World Bank World Development Indicators.
Note: The CBI is defined as in Dincer and Eichengreen (2014), extrapolated as described in the Appendix. The index
ranges from 0 (least independent and transparent) to 15 (most independent and transparent). Inflation refers to
year-on-year inflation. AEs = advanced economies; CBI = central bank independence and transparency index; EAP = East
Asia and Pacific; ECA = Europe and Central Asia; EMDEs = emerging market and developing economies; LAC = Latin
America and the Caribbean; LICs = low-income countries; MNA = Middle East and North Africa; SAR = South Asia;
SSA = Sub-Saharan Africa.
C. Columns indicate the median inflation levels and inflation volatility in country-year pairs with a CBI in the top quartile of
the sample. Bars denote medians for country-year pairs in the bottom quartile. The difference in inflation levels and
volatility between high and low CBI is statistically significant at the 1 percent level.
D. Blue bars show the coefficient estimates from bivariate panel regressions of changes in average inflation between the
1980s and the 2010s on the change in average CBI over the same period (Tables A.1.3.1 and A.1.3.2, Annex 1.3). Vertical
lines are ±1.64 standard errors of the coefficient estimate.
wage indexing, possibly enforced by highly collectivized wage bargaining, can

entrench short-term inflation shocks into longer-term inflation trends and
inflation expectations (Taylor 1979).
Beyond wage indexation, labor market deregulation has been associated with
lower inflation persistence (Biroli, Mourre, and Turrini 2010). In the Euro Area,
in particular, arrangements that facilitate labor market flexibility—such as lower
FIGURE 1.16 Government debt and inflation

Over the past five decades, government debt has grown in advanced economies,
especially after the global financial crisis. In EMDEs, it has fallen below early 1990s peaks.
Higher government debt has been associated with higher inflation volatility in EMDEs.
A. General government debt B. Countries with fiscal rules
C. Inflation, by government debt D. Correlation between disinflation and

changes in government debt (1980s-2010s)
Source: IMF Fiscal Rules Dataset; IMF World Economic Outlook database; World Bank World Development Indicators.
Note: Inflation refers to year-on-year inflation. AEs = advanced economies; EMDEs = emerging market and developing
economies; GDP = gross domestic product.
A. Median across countries.
C. Columns indicate the median inflation levels and inflation volatility in country-year pairs with government debt in the top
quartile of the sample. Horizontal bars denote medians for country-year pairs in the bottom quartile.
D. Blue bars show the coefficient estimates from bivariate panel regressions of changes (between 1980-89 and 2010-17)
in inflation on average government debt as percentage of GDP in the 1980s. Vertical lines are ±1.64 standard errors of the
coefficient estimate.
employment protection, less union density, and more limited collective

bargaining—have been found to reduce inflation persistence (Jaumotte and
Morsy 2012). A similar result was found for a broader sample of countries in
the Organisation for Economic Co-operation and Development (OECD)
(Geronikolaou, Spyromitros, and Tsintzos 2016).
Greater product market flexibility can enhance competition and vice versa. By
making wages and prices more flexible, including by deregulating administrative
prices, it reduces and makes more transitory the real effects of monetary policy
and, hence, reduces the incentive for central banks to use stimulus to boost
growth and employment (Rogoff 2003). As a result, inflation expectations and
inflation could be lower. Empirically, there is some tentative evidence of lower
inflation persistence among advanced economies with greater product market

flexibility (Biroli, Mourre, and Turrini 2010).
Trends in labor and product markets. Since 2000, labor market flexibility has
increased in advanced economies and EMDEs (Figure 1.17). For example, in
EMDEs, union membership declined sharply to 5-15 percent of the labor force
in 2013, well below the 2000 level (15-35 percent). In some EMDEs with
already-elevated wage bargaining coverage, union membership has expanded,
but it remains well below the levels in advanced economies, where it has receded
somewhat since 2008.
Correlation with inflation. Lower union membership has been associated with
lower inflation and inflation volatility in EMDEs (Figure 1.17). In EMDEs in
the bottom third of the sample for union membership, inflation was about 1
percentage point lower, on average, and inflation volatility was less than half
that in the top third of the sample.11 For advanced economies, in contrast, the
difference was modest.
Economic structure
Literature. Unless commodity-reliant economies can fully stabilize output

growth and exchange rate swings, they may face greater macroeconomic
volatility, including inflation volatility, as a result of volatile commodity prices
(Bayoumi and Ostry 1997). Conversely, countries that rely heavily on food
imports may be subject to greater global food price volatility. However, the
consequences of resource reliance for macroeconomic stability depend on policy
frameworks: monetary policy independence and financial openness may mitigate
the volatility caused by global commodity price swings in resource-based
economies (Aizenman, Chinn, and Ito 2010).
Economic structure in EMDEs. About two-thirds of EMDEs rely heavily on

commodity exports. In these countries, the commodity sector accounts for
30-80 percent of exports, 20-70 percent of government revenues, and 5-20
percent of GDP. The fall in commodity prices from their peaks in early 2011
has encouraged some economic diversification. In 2016, the share of exports
accounted for by commodities in these countries had fallen to 25-70 percent.
Correlation with inflation. The oil price plunge during 2014-16 helped reduce
inflation, particularly among EMDEs with a high share of energy imports in
GDP. For every additional 10 percentage points of GDP in higher energy
11 These measures are unavailable for a panel of countries from the 1970s to the 1990s. Hence, labor
market variables were not included in the panel regression.

FIGURE 1.17 Labor markets and inflation

Over the past two decades, wage-setting institutions and labor markets more broadly, have
become more flexible.
A. Union membership B. Labor market flexibility
C. Collective bargaining coverage D. Inflation by union membership
Source: Fraser Institute’s Economic Freedom of the World Database; ILOStat; World Bank.
Note: AEs = advanced economies; EMDEs = emerging market and developing economies.
A. Median trade union density rate in 2000 and 2013 for all, AEs, and EMDEs, with 25th and 75th percentile error bars.
Data available from 2000 to 2013.
B. Median labor market flexibility index of the Fraser Institute’s Economic Freedom Index in 2000 and 2013 for all, AEs,
and EMDEs, with 25th and 75th percentile error bars.
C. Median and interquartile range of share of workers covered by collective bargaining in 2008 and 2013. For 2008, data
are only available for four advanced economies and five EMDEs.
D. Low union membership indicates the bottom third (below 17 percent) of the sample, high union membership indicates
the top third (above 30 percent) of the sample. The sample includes 75 economies for 2000-13.
imports, disinflation over the past four decades was about 0.7 percentage point
steeper. In contrast, higher net food imports were associated with slower
disinflation over the past four decades.
Other factors
In some countries, disinflation has been attributed to population aging and the
growing digitalization of services.
Population aging. In Japan, population aging may have contributed to
chronically low inflation, as the burden of rising pension bills weighed on
consumption of the working-age population; asset sales of older households
depressed asset prices; and shifts toward lower-risk household assets (especially
household holdings of government bonds) by older households reduced the
funding envelope for fixed investment.12 Studies based on broader groups of
countries have been less conclusive.13
Digitalization of services. In some advanced economies, disinflation has been
attributed partly to the growing digitalization of services, including e-commerce
or sharing services (Goolsbee and Klenow 2018). Although electronic sales by
enterprises may still be modest, they have grown rapidly (Ciccarelli and Osbat
2017). By introducing cheaper distribution channels and increasing price
transparency, these services may increase competitive pressures and, by
increasing efficiency, generate cost savings (Dong, Fudurich, and Suchanek
2017). However, digitalized services may foster market concentration and the
emergence of “superstar firms” that reduce competitive pressures in the long run
(Autor et al. 2017).14 Empirical studies have found little evidence of significant
deflationary pressures from such digitalization (Charbonneau et al. 2017). For
example, using big data techniques, Cavallo and Rigobon (2016) and Cavallo
(2017) find that inflation in online retail prices closely matches official U.S.
price indexes. In eight other G20 countries, the evolution of online prices has
also been similar to that of offline prices, although possibly with more frequent
but smaller price changes.15
Conclusion
The chapter documents the widespread (across countries) and broad-based
(across components) decline in global inflation over the past four to five decades.
Global inflation fell from a peak of 16.6 percent (annual average) in 1974 to 2.6
percent in 2017 and further to 2.3 percent in the second half of 2018. In
advanced economies, it has fallen steadily since the mid-1980s and in EMDEs
since the mid-1990s. In EMDEs, inflation declined from a peak of 17.3 percent
(annual average) in 1974 to 3.5 percent in 2017 and, in LICs, from 24.9 percent
(annual average) in 1994 to 5.0 percent in 2017. By 2000, global inflation had
stabilized at historically low levels before the global financial crisis set off a
12 Andersen, Botman, and Hunt (2014); Imam (2013); Katagiri (2018).

13 Although the Japan-specific studies referred to in the preceding footnote agree that population aging
has been deflationary, studies based on groups of OECD countries are mixed: Yoon, Kim, and Lee
(2014); Bobeica et al. (2017); and Inoue et al. (2016) find a negative relationship between the population
share of elderly and inflation, and Juselius and Tákáts (2015) find the opposite.
14 Rapid technological change has also raised concerns that inherent quality improvements are
underestimated and, hence, price levels and inflation are overestimated. Empirical studies have found
little evidence to support this hypothesis (Cavallo 2017).
15 Cavallo (2017); Gorodnichenko, Sheremirov and Talavera (2016); Gorodnichenko and Talavera
(2017).
period of renewed disinflation. Lower inflation has been accompanied by lower

inflation volatility, especially in advanced economies.
The global disinflation has been broad-based. It has occurred in most countries,
all EMDE regions, all measures of inflation, and all components of inflation.
The current low and stable inflation episode resembles that during the Bretton
Woods fixed exchange rate system in the post-war period until 1971 and during
the gold standard of the early 1900s. When these historical exchange rate
systems faltered, inflation surged. In today’s context also, there are reasons to
believe that structural factors that have supported disinflation over the past five
decades may be fading.
Global disinflation has been supported by a confluence of structural, cyclical,
and policy-related factors. A major structural change has been the
unprecedented international trade and financial integration along with rapid
technological progress. In the median EMDE, like in the median advanced
economy, trade has increased by half since 1970, to 75 percent of GDP in 2017,
and international assets and liabilities have more than tripled, to 166 percent of
GDP in 2016 (although still only half the level in advanced economies).
On the policy front, the adoption of stronger monetary, exchange rate, and fiscal
policy frameworks has changed policy makers’ approach to price stability.
Twenty-three EMDEs have followed in the footsteps of Poland, the first EMDE
to introduce an inflation targeting monetary policy framework, in 1998.
Reforms of labor and product markets have made EMDEs more flexible by
improving competition and reducing price rigidities. Technological changes
have been transforming production processes in ways that also affect the
formation of prices. In addition to these long-term structural changes, severe
global and country-specific shocks have depressed inflation for an extended
period.
The gains of the past four to five decades in terms of inflation are by no means
guaranteed. Inflation can easily make a comeback if the fundamental structural
and policy changes that have compressed inflation over the past five decades lose
momentum or even reverse. However, as long as strong monetary policy
frameworks are supported by sound fiscal policies and institutional structures, it
would be possible to keep in check the inflationary implications of fluctuations
in business and financial cycles, and movements in commodity prices.
EMDEs are particularly vulnerable to rising external inflation pressures. Their

inflation expectations are less well anchored than in advanced economies. In the
absence of strong monetary policy frameworks, exchange rate movements can
amplify inflation pressures. Hence, a temporary, externally driven inflation surge
can translate into an increase in inflation that EMDE central banks would
struggle to rein in. If that happens, little support for macroeconomic

stabilization may be forthcoming from fiscal policy, since EMDE fiscal positions
are vulnerable to rising borrowing costs when investors reassess risks.
Future research could take two directions. First, the relative contributions of
long-term structural changes to global disinflation over recent decades could be
more formally quantified. This could be done in a general equilibrium
framework, since most regression models are poorly suited to uncovering the
relationships between such slow-moving variables. Second, future work could
examine more formally the degree of comovement in long-term inflation trends,
as Chapters 2 and 3 do for comovement in short-term inflation. This could be
set in the context of a more refined measure of trend inflation, such as trends of
different lengths that could be identified in frequency domain analysis.
ANNEX 1.1 Effects of inflation on inequality

and poverty
Poorer households may suffer greater welfare losses from inflation than wealthier
households. In general, poorer households are less able to protect the real value of their
income and assets from the impact of inflation. Although the evidence of a positive
correlation between inflation and inequality or poverty is mixed at the aggregate
level, the links are more established at the household level. The adoption of a credible
monetary policy regime that maintains low and stable inflation may help reduce
poverty and inequality. In addition, targeted pro-poor fiscal interventions and
structural reforms to improve access to financial services for the poor could further
mitigate any adverse effects of inflation on inequality and poverty.
Introduction
Inflation can have adverse economic effects on households and other sectors of
the economy through direct and indirect channels.1 Its effects can also differ
among different groups of households. For example, poorer households tend to
be less able than wealthier households to protect the real value of their income
and assets from the impact of anticipated inflation, as poorer households are
more reliant on wage income, have less access to interest-bearing accounts, and
are unlikely to have significant holdings of other financial or real assets apart
from cash. They may also face a higher or more volatile rate of inflation than
wealthier households, due to differences in the composition of their
consumption baskets—for instance, poorer households may be relatively more
exposed to food price volatility. Less directly, there are close links between
inflation, monetary policy, and growth. If high inflation results in tighter
monetary policy or lower economic growth, it can thereby indirectly affect
poverty and inequality.
If the negative effects of inflation fall disproportionately on the poor, it could

worsen poverty rates, inequality, or both. Furthermore, because inflation has
typically been higher in emerging market and developing economies (EMDEs)
than in advanced economies over the past half-century, any negative effects
arising from inflation on inequality and poverty may be larger in EMDEs.
Although the empirical evidence at the aggregate level is somewhat mixed, the
negative effects at the household level are more established. Policy measures to
control inflation or mitigate its regressive effects, such as the adoption of a
credible monetary policy regime, and targeted pro-poor fiscal interventions have
1 Fischer and Modigliani (1978) document 25 direct and 25 indirect channels through which inflation
can affect different sectors of the economy.

the potential to attenuate inequality and poverty. For EMDEs that are
implementing structural reforms and macroeconomic stabilization policies, the
potentially beneficial effects of controlling inflation may offset some of the
negative effects associated with such policies.
Against this background, this annex addresses the following questions:
• What are the direct channels through which inflation affects inequality and
poverty at the household level?
• What are the indirect channels through which inflation affects inequality
and poverty?
• What is the impact of inflation on overall inequality and poverty?
• What are the major policy implications?
Direct channels from inflation to inequality and poverty
Inflation can have different effects on different groups of households. In a survey

of almost 32,000 households in 38 countries, Easterly and Fischer (2001) found
that the poor were much more likely than the rich to state that inflation was a
problem. The composition of income, assets, and consumption baskets tends to
be such that poorer households suffer greater losses in the real value of their
income and wealth as a result of inflation than wealthier households, so that
inflation leads to increases in inequality. However, the very poor—households
living below the global poverty line of $1.90 per day—may be less vulnerable to
inflation as they have minimal wage income or assets. Inflation is also closely
linked to monetary policy and economic growth and can indirectly affect
poverty and inequality.
Composition of income. In advanced economies, the poor tend to rely more

heavily on wage income, transfers, and pensions, and less on income from capital
than higher-income households (Erosa and Ventura 2002) (Figure A.1.1.1). As
wages tend to lag price inflation, inflation can reduce the real value of nominal
wages, reducing the incomes of the poorest households relative to those of the
richest. This also shifts income away from labor income toward profits, which,
given the distribution of income between rich and poor, will also tend to worsen
inequality (Laidler and Parkin 1975; Fischer and Modigliani 1978). Poorer
households may also be less likely to benefit from indexed wages (for example,
through unions) or through inflation-proof benefits such as health insurance
(Bulir 2001). The impact of inflation on pensions and transfers depends on their
prevalence in society, as well as on the level of indexation. Welfare payments in
most developed countries have some form of indexation, although adjustments
FIGURE A.1.1.1 Composition of household income, wealth, and

consumption
The composition of household income, wealth, and consumption varies significantly by
income bracket and country. In the United States, the poorest households rely more heavily
on wages and transfers, while the richest derive more income from capital. In EMDEs, such
as Brazil, nonmonetary income is more important for poorer households. In EMDEs, the
poorest households spend a greater share of their income on necessities such as food than
the wealthy. EMDEs also spend more on food than higher-income countries such as the
United States.
A. Sources of U.S. household income, B. Sources of Brazilian household income,

by income percentile by income percentile
C. Composition of EMDE consumption D. Composition of U.S. consumption

expenditure, by income group expenditure, by income group
Source: Eurostat; Federal Reserve Board Survey of Consumer Finances; World Bank.
A.B Investment income includes interest income, dividends, and capital gains.
B. Income percentiles in Brazil imputed from published income levels to be broadly comparable with U.S. brackets. Data are
not published in standard income quintiles. Aggregate data on EMDEs for source of income by income group were not
available.
C.D. “Housing” includes utilities such as electricity and gas. “Transport” includes purchases of new vehicles as well as
motor fuel. “Other” includes furnishings, personal care, and finance and insurance services.
C. Sample of 90 EMDEs, including 24 low-income countries.
tend to lag inflation, which can result in erosion of real incomes for some
income groups in the short run (Minarik 1979; Burdick and Fisher 2007).
Although the channels outlined above also apply to EMDEs, households in

EMDEs often rely heavily on nonmonetary income, such as subsistence farming
or barter. For example, in Brazil, nonmonetary income accounts for more than a
quarter of total income among the poorest fifth of households. Being
nonmonetary, this source of income is less vulnerable to inflation than is wage

income. For households living below the poverty line of $1.90 a day per head,
nonmonetary income may form most of their income, reducing their
vulnerability to inflation.
Composition of assets during sustained high inflation. The poor tend to hold
most of their assets in cash and have less access to financial products that can
protect them against inflation, as these products typically have some entry cost
associated with their use (Kahn 1997; Mulligan and Sala-i-Martin 2000; Erosa
and Ventura 2002). For example, in the United States, most households have a
transaction or current account at a financial institution, with 94 percent of the
poorest 20 percent of households holding one. However, many fewer households
have savings products, and the distribution is very skewed: the wealthiest 20
percent of households are four times as likely as the poorest to hold certificates of
deposit and six times as likely to hold savings bonds. The very richest households
(top 10 percent) are 12 times as likely as the poorest 20 percent to hold equities
and 23 times as likely to hold pooled investment funds. New financial
technologies are beginning to broaden access to financial services for poorer
households (Demirgüç-Kunt et al. 2018). The differences are even more stark
when considering differences in wealth. Although an inability to protect against
inflation is unlikely to affect the very poor, because their holdings of cash will be
minimal, episodes of high inflation and especially hyperinflation could tip some
households into poverty by eroding the value of their savings and lead to greater
inequality (Cysne, Maldonado, and Monteiro 2005; Areosa and Areosa 2016).
Composition of assets during unexpected spells of inflation. A surprise increase

in inflation can erode the real value of assets. Because the wealthy tend to be net
creditors, such an episode of unanticipated inflation could lead to a reduction in
their wealth and a corresponding increase in the wealth of net debtors, by
reducing the real value of their debt (Palmer and Barth 1977). In practice, this
channel is unlikely to benefit the poorest households, because they tend to have
minimal holdings of assets and liabilities (Romer and Romer 1998). For
example, in Brazil, 0.9 percent of the poorest decile of households have a
mortgage and 6.3 percent have a credit card, compared with 6.1 percent and
44.2 percent, respectively, for the wealthiest decile. This channel seems unlikely
to have much of an impact on poverty rates, particularly in EMDEs. It may have
some impact on inequality by eroding the real value of assets among the top
income percentiles. For example, in a study of U.S. households, Doepke and
Schneider (2006) find that unanticipated inflation has tended to benefit young,
middle-class households with fixed-rate mortgage debt, but it hurts older and
wealthier households. However, holders of equities, who tend to be in the upper
income deciles, typically fare better, because these instruments and the associated
income streams are more inflation-proof.
Composition of consumption baskets. Although measures of consumer price

inflation are calculated using a basket of goods that is representative of the
average consumer, the actual composition of consumption baskets varies
significantly by income group—because households choose different goods and
services or use differently priced versions of the same goods and services. For
example, the bottom quintile of households (by income) in EMDEs spend
roughly half their income on food, compared with just 20 percent for the top
quintile. This difference is more pronounced in EMDEs than in advanced
economies, as the share of food in total consumption is much smaller in general
in the latter.
In addition to differences in the composition of consumption baskets, other
factors can play a role. Using data from 5 million retail scanner transactions,
Kaplan and Schulhofer-Wohl (2017) find that differences in the prices paid for
the same goods explain two-thirds of the heterogeneity in inflation rates among
U.S. households. High-income households are more able to substitute away
from higher-quality goods toward lower-quality goods during times of economic
crisis, and they can also take greater advantage of discounts on bulk purchases
and sales, as they do not face the same liquidity constraints as the poor (Argente
and Lee 2015; Orhun and Palazzolo 2018).
In general, the evidence suggests that inflation rates vary among income groups,
although there is disagreement about whether these effects are temporary or
permanent. Some studies have found substantial, long-term differences in
effective inflation rates between the poorest and wealthiest households, with the
inflation rates faced by the poor outpacing those faced by the rich by 0.4 to 0.8
percentage point a year (Levell and Oldfield 2011; Kaplan and Schulhofer-Wohl
2017; Weichenrieder and Gurer 2018). Other studies have found significant
cyclical, but not permanent, differences in inflation rates between income groups
(Hobijn and Lagakos 2005; Oosthuizen 2007), with some evidence that more
vulnerable groups are prone to greater variability in inflation (McGranahan and
Paulson 2006). In addition, the choice of deflator used in the calculation of the
poverty line or the indexation of welfare benefits can affect the incomes of the
poor (Gibson, Le, and Kim 2017). Adjusting for different rates of inflation for
different groups can also have a material impact on inequality measures
(Weichenrieder and Gurer 2018).
Special case of food price inflation. Although the poor in EMDEs are more
affected by increases in food prices than are higher-income households, a large
number of the poor in EMDEs are food producers as well as consumers. A rise
in food prices could therefore raise the incomes of these households. More than
one-fifth of households around and below the poverty line are net food sellers in
the average EMDE and would therefore benefit from higher food prices.
However, in the aggregate, the majority of the poor in EMDEs and low-income
countries (LICs) are net buyers of food and, as a result, food price spikes tend to
increase poverty overall. For example, the rise in food prices between 2006 and
2008 is estimated to have increased the number of poor by 105 million (Ivanic
and Martin 2008). This topic is covered in Chapter 6.
Indirect channels from inflation to inequality and poverty

Economic growth. Inflation can indirectly affect poverty and inequality through
its impact on economic growth. Historically, low and stable inflation, combined
with well-anchored inflation expectations, has been associated with greater short-
term stability of output and employment growth and higher long-term
economic growth (Bruno and Easterly 1998; Eggoh and Khan 2014) (Figure
A.1.1.2). These effects seem to be nonlinear, with several studies finding a
negative relationship between inflation and growth if inflation is higher than a
certain threshold, but they find no relationship when inflation is below that
threshold (Barro 1996; Khan and Senhadji 2001). Several channels account for
the beneficial effects of low and stable inflation on economic activity, including
reduced uncertainty for investors and households, greater pricing transparency,
and greater financial stability (Box 1.1). In turn, higher economic growth
typically reduces poverty.
Stronger economic growth has generally been found to be beneficial for the poor
and has been associated with steeper declines in poverty rates (Dollar and Kraay
2004; Dollar, Kleineberg, and Kraay 2016). The relationship has been highly
nonlinear, with poverty responding less to growth when the initial poverty rate is
high (Ravallion 2012; World Bank 2010). The relationship between economic
development and inequality has been hypothesized by the so-called Kuznets
curve, which proposes an inverse U-shape relationship (Kuznets 1955). At low
levels of economic development, inequality is low, with little differentiation
between households. As economies develop, inequality tends to rise amid
increasing differentials in productivity and pay between workers. Finally,
inequality starts to fall beyond a certain level of development, as societies choose
to reduce inequality through taxes and transfer payments (Milanovic 1994).
However, there is limited empirical evidence to support this theory, with many
studies showing no evidence of such a relationship (Gallup 2012). Piketty
(2014) finds that growth in the recent episode of globalization has been
accompanied by greater inequality in high-income countries.
Conventional monetary policy. Inflation can also have indirect effects on

inequality and poverty through its close links with unemployment, growth, and
monetary policy. It is well established that monetary policy has redistributive
effects, although these may be temporary. Romer and Romer (1998) distinguish
between short-run and long-run effects. In the short run, expansionary monetary
FIGURE A.1.1.2 Inflation, inequality, and poverty

The relationship between inflation, growth, inequality, and poverty varies across countries.
Low and stable inflation has been associated with higher rates of economic growth,
although the relationships can be nonlinear. In turn, higher economic growth has been
associated with declines in poverty rates.
A. GDP growth under different inflation B. Growth and change in the poverty rate
environments
Source: World Bank.

Note: GDP = gross domestic product.
A. Average real GDP growth from 1980 to 2016 for countries with average inflation or standard deviation of inflation in the
top quartile (“High”) and in the bottom quartile (“Low”).
B. Inflation and GDP data are averaged over 1980-2016.
policy raises output, lowers unemployment, and reduces poverty. However, the
effects are only temporary, as a persistent expansion is inflationary, which
requires monetary policy tightening, which in turn increases unemployment,
causing poverty to rise again (a mechanism modeled in a dynamic stochastic
general equilibrium framework by Areosa and Areosa 2016). The empirical
results are somewhat mixed: Furceri, Loungani, and Zdzienicka (2018) find that
a contractionary monetary policy shock increases inequality in the short run,
while Ballabriga and Davtyan (2017) find that it can lead to a decline in
inequality. In the long run, however, credible monetary policy that results in low
and stable inflation can improve outcomes for the poor, by providing favorable
conditions for economic growth.
Unconventional monetary policy. More recently, unconventional monetary

policy tools have been utilized by central banks in advanced economies amid
concerns about persistently low inflation or deflation and short-term interest
rates that are close to their zero lower bound. Although the channels through
which these tools operate are similar to those used by conventional tools, the
strength of these channels may vary (Bank of England 2012). Empirical evidence
thus far suggests that, using unconventional tools, the impact of monetary
expansion on inequality is fairly neutral to negative (lowers inequality). The poor
benefit from an increase in labor income via a reduction in unemployment and
increase in wages and, for savers, the decrease in returns on assets is offset by
increased capital gains (Casiraghi et al. 2018; Ampudia et al. 2018).
Effects of inflation on overall inequality and poverty

Although the evidence on the effects via individual links suggests that poorer
households are generally more adversely affected by inflation than wealthier
ones, the empirical results for the overall link between inflation and inequality
are inconclusive. Much of the literature was produced in the late 1990s, and
there are relatively few recent studies. Inflation trends have evolved substantially
over the past 20 years, with a generalized downward trend globally. The results
vary between single-country studies and cross-country studies, and between
advanced economies and EMDEs. Although correlations between the variables
have been found, there is less evidence of clear causation from inflation to
inequality and poverty, with some studies suggesting the causality goes in the
opposite direction.2 In general, the literature suggests that slightly higher
inflation is associated with mildly lower inequality in countries where inflation is
already low (typically, advanced economies), but that high inflation is associated
with higher inequality in countries where inflation is already high (typically,
EMDEs).
Single-country studies. Parker (1998) surveys the early literature, based on 12

single-country studies, and finds that all but three show that higher inflation is
associated with lower inequality (for example, Ashworth 1994; Balke and Slottje
1993). However, almost all these studies focus on advanced economies (mainly
the United States), so the results may be less applicable to EMDEs. Other
studies focusing on single advanced economies come to a similar conclusion
(Doepke and Schneider 2006; Maestri and Roventini 2012), except for Jantti
and Jenkins (2010), who find little evidence of a relationship between inflation
and income inequality in the United Kingdom. Single-country studies on
EMDEs, such as India (Datt and Ravallion 1998), the Philippines (Blejer and
Guerrero 1990), and Brazil (Ferreira and Litchfield 2001), find that higher
inflation is associated with a lower share of income held by the poor or higher
inequality. Looking at seven single studies of advanced economies and EMDEs
together, Bulir and Gulde (1995) find that the impact of inflation on different
income groups within countries varies between countries, with a positive
correlation between inflation and inequality more likely in LICs that have a less
developed financial sector.
Cross-country studies. Galli and van der Hoeven (2001) review single-country
and cross-country studies prior to 2000. They find that the time-series studies
(the majority of which focus on the United States) almost always find higher
2 In a study of Brazil during 1981-93, a fall in inequality, despite being associated with declining
inflation, was attributed to structural and policy changes including convergence of incomes between rural
and urban areas, and social transfers to the poor (Ferreira and Litchfield 2001).
inflation to be associated with lower inequality, whereas the cross-country

studies find higher inflation to be associated with higher inequality and poverty
(Figure A.1.1.2). Several other studies that use cross-country samples also
document a positive correlation between inflation and income inequality
(Romer and Romer 1998; Easterly and Fischer 2001; Agenor 2002; Albanesi
2007; Thalassinos, Ugurlu, and Muratoğlu 2012). However, even studies that
find statistically significant coefficients on inflation typically find little
explanatory power of their models, and the relationship between the poverty rate
and inflation is less apparent than the relationship with inequality.
Nonlinear relationship between inflation and inequality. These mixed

empirical results may reflect nonlinear relationships between inflation and
inequality or poverty. Several studies find evidence of a nonlinear relationship,
with considerable differences in the correlation between inflation and inequality
depending on the initial rate of inflation (Galli and van der Hoeven 2001; Bulir
2001; Monnin 2014; Siami-Namini and Hudson 2017). Bulir (2001) reports
that countries in hyperinflation had Gini coefficients that were 8 points higher,
on average, than countries with high inflation but not hyperinflation. The
benefit of moving from hyperinflation to high inflation was significant, but
moving from high inflation to very low inflation (less than 5 percent) had a
negligible effect.
Policy recommendations
Maintain a low-inflation environment. Although it is not definite, the evidence
suggests that achieving stable and low inflation is associated with better poverty
and inequality outcomes, with the benefits being greatest among low-income,
high-inflation countries. Lowering income inequality by controlling inflation
may be less costly than through other social choices (Bulir 2001). This suggests
that the adoption of a credible monetary policy regime by policy makers in
EMDEs can lead to improved inequality and poverty outcomes. The results are
less clear-cut for advanced economies, where low inflation is already established,
with some evidence that the opposite relationship holds, so that slightly higher
inflation may reduce inequality.
Improve competition. Policy makers have a range of tools beyond monetary
policy to improve income inequality and poverty, but they have few tools to
address the effects arising specifically from inflation. Structural reforms to
improve competition in the financial sector can lower costs and increase access
to savings products that can help poorer households protect the real value of
their assets from inflation (Beck, Demirgüç-Kunt, and Levine 2004; Claessens
2006). Such reforms have also been found to increase informal business
ownership, employment, and income, with a larger benefit accruing to lower-
income households (Bruhn and Love 2014).
Improve granularity in inflation measures and fiscal support. The calculation

of alternative indexes of inflation for different income groups would provide
greater information on the inflation rates actually experienced by the poor and
could be used as an alternative benchmark for indexing welfare payments. This
would reduce the erosion of their real value if inflation for poorer households
was higher than the economywide inflation rate. Finally, the use of targeted
subsidies could help alleviate poverty and inequality if they are focused on
products, particularly food items, that are disproportionately consumed by the
poor and prone to more volatile inflation.
ANNEX 1.2 Low-income countries

Low-income countries (LICs) are defined as those with gross national income
(GNI) per capita, calculated using the World Bank Atlas method, of $995 or
less in 2017; middle-income countries as those with GNI per capita between
$996 and $12,055 in 2017; and high-income countries as those with GNI per
capita of $12,056 or more in 2017. These classifications are revised in July every
year.
As of 2018, LICs include Afghanistan, Benin, Burkina Faso, Burundi, Central

African Republic, Chad, the Comoros, the Democratic Republic of Congo,
Eritrea, Ethiopia, The Gambia, Guinea, Guinea-Bissau, Haiti, the Democratic
People’s Republic of Korea, Liberia, Madagascar, Malawi, Mali, Mozambique,
Nepal, Niger, Rwanda, Senegal, Sierra Leone, Somalia, South Sudan, the Syrian
Arab Republic, Tajikistan, Tanzania, Togo, Uganda, the Republic of Yemen,
and Zimbabwe. Annual inflation data since 1970 are available for 27 LICs
(excluding Eritrea, the Democratic People’s Republic of Korea, Somalia, South
Sudan, Syria, Tajikistan, and Yemen).
In 1987, the first year classifications were published, 49 economies (excluding

most economies affiliated with the Soviet Union) were classified as LICs. Of
today’s LICs, Senegal, Syria, Yemen, and Zimbabwe were classified as middle-
income countries in 1987. In addition to today’s LICs, Bangladesh, Bhutan,
Cambodia, China, Equatorial Guinea, Ghana, Guyana, India, Indonesia, Kenya,
the Lao People’s Democratic Republic, Lesotho, Maldives, Mauritania,
Myanmar, Nigeria, Pakistan, São Tomé and Príncipe, Solomon Islands, Sri
Lanka, Sudan, Vietnam, and Zambia were classified as LICs in 1987.
ANNEX 1.3 Regression analysis

A series of bivariate regressions is estimated to identify the main correlates of the
decline in inflation between the 1980s and the 2010s. The sample includes 73-
77 countries (depending on the availability of the correlates of inflation), of
which 49-53 countries are emerging market and developing economies. Coun-
tries with populations of less than 3 million are dropped, since they tend to be
outlier observations.
Specifically, the regression is estimated as ∆inflation it = α + β X it , with robust
standard errors. All changes are between averages for 1980-89 and 2010-17. The
constant α in this regression denotes the unconditional average decline in infla-
tion over the three decades. To avoid multicollinearity, since most of the regres-
sors are highly correlated with each other, the regression only estimates bivariate
correlations.
The regressors X it include the change in trade openness (identified as trade as a
percentage of gross domestic product [GDP]); the change in capital account
openness (defined as the Chinn-Ito index of financial openness); the switch to
an inflation targeting regime; the switch to a pegged exchange rate regime (as
defined by Shambaugh [2004]); the change in Dincer and Eichengreen’s (2014)
central bank independence and transparency index; the switch to a status of be-
ing highly integrated into global value chains (as defined in the Appendix); the
initial level of government debt as a percentage of GDP; net energy imports as a
percentage of GDP; and net food imports as a percentage of GDP.
TABLE A.1.3.1 Correlates of change in CPI inflation: Full sample

Panel A
Variables
0.3077**
Net food imports (percent of GDP)
[0.160]
-0.0672***
Net energy imports (percent of GDP)
[0.024]
-6.5383***
Change to inflation targeting regime
[2.285]
Change to pegged exchange rate -3.3842*

regime [2.235]
Change in central bank transparency

index (point increase)
-3.5727*** -3.8800*** -2.8199*** -3.5029***
Constant
[0.714] [0.802] [0.724] [0.812]
Observations 79 79 81 81
R-squared 0.068 0.036 0.129 0.048
Panel B
Variables
Change in central bank
-0.9784***
transparency index (point
[0.370]
increase)
Change in trade openness -0.0182
(percentage points of GDP) [0.026]
Change in capital account
-9.3815***
openness index (point
[2.199]
increase)
Change in international assets
-0.0003
and liabilities (percentage
[0.001]
points of GDP)
Initial government debt -0.0005
(percent of GDP) [0.023]
-2.1583*** -3.4944*** -2.6809*** -3.6822*** -4.0227***
Constant
[0.976] [0.830] [0.656] [0.867] [1.466]
Observations 77 80 80 81 77
R-squared 0.092 0.007 0.219 0.001 0.000
Note: Standard errors are in square brackets. The dependent variable is the change between the average inflation rate
during 2010-17 and the average inflation rate during 1980-89. All changes are between averages for 2010-17 and 1980-89.
Inflation targeting regime and pegged exchange rate regime (as defined by Shambaugh [2016]) are dummy variables. Euro
Area economies are considered floating rate regimes. The central bank transparency index (0 = least, 15 = most) is from
Dincer and Eichengreen (2014). The capital account openness index (0 = closed, 1 = open) is from Chinn and Ito (2008).
The dummy variable for high participation in global value chains is defined in the Appendix. CPI = consumer price index;
GDP = gross domestic product.
*** indicates statistical significance at the 1 percent confidence level, ** at the 5 percent level, and * at the 10 percent level.
TABLE A.1.3.2 Correlates of change in CPI inflation: EMDEs

Panel A
Variables
Net food imports (percent 0.3891***
of GDP) [0.164]
-0.0748**
Net energy imports (percent of GDP)
[0.039]
-9.1011***
Change to inflation targeting regime
[3.001]
-2.8823
Change to pegged exchange rate regime
[2.921]
-3.8778*** -4.0871*** -3.0054*** -4.1452***
Constant
[1.044] [1.170] [1.105] [1.160]
Observations 46 46 47 47
R-squared 0.125 0.027 0.176 0.030
Panel B
Variables
Change in central bank -1.2126**

transparency index (point increase) [0.589]
Change in trade openness -0.0101
(percentage points of GDP) [0.037]
Change in capital account openness -8.9658***
index (point increase) [3.332]
Change in international assets and

-0.0050**
liabilities (percentage points of
[0.003]
GDP)
Initial government debt 0.0122

(percent of GDP) [0.032]
-2.5910*** -4.4366*** -3.6367*** -4.1563*** -5.2233***

Constant
[1.326] [1.238] [1.017] [1.150] [2.334]
Observations 45 46 47 47 46
R-squared 0.092 0.002 0.149 0.033 0.003
Note: Standard errors are in square brackets. The dependent variable is the change between the average inflation rate
during 2010-17 and the average inflation rate during 1980-89. All changes are between averages for 2010-17 and 1980-89.
Inflation targeting regime and pegged exchange rate regime (as defined by Shambaugh [2016]) are dummy variables. Euro
Area economies are considered floating rate regimes. The central bank transparency index (0 = least, 15 = most) is from
Dincer and Eichengreen (2014). The capital account openness index (0 = closed, 1 = open) is from Chinn and Ito (2006).
The dummy variable for high participation in global value chains is defined in the Appendix. CPI = consumer price index;
EMDEs = emerging market and developing economies; GDP = gross domestic product.
*** indicates statistical significance at the 1 percent confidence level, ** at the 5 percent level, and * at the 10 percent level.
ANNEX 1.4 Lessons from U.S. disinflation in 1979-82

U.S. inflation declined from double-digits in August 1979 to below 4 percent by
the end of 1982. This disinflation highlighted the benefits of shifting central
banks’ focus to price stability, building credibility, and establishing stabilizing
monetary policy rules.
The Great Inflation of 1965-82 has been described as the defining
macroeconomic event of the second half of the 20th century (Bryan 2018).
Siegel (1994) described it as “the greatest failure of American post-war history.”
Meltzer (2005) attributed to the Great Inflation the fall of the Bretton Woods
system of fixed exchange rates, the bankruptcy of the thrift industry (U.S.
savings banks), heavy capital taxation, and a redistribution of wealth and
income. The challenges associated with the subsequent disinflation transformed
the understanding of the role of central banks and monetary policy.
Against this backdrop, this annex discusses the following questions:
• How did U.S. disinflation evolve during the 1980s?
• What was the role of monetary policy in U.S. disinflation?
• What lessons have been drawn from U.S. disinflation?
Evolution of disinflation during 1979-82

By August 1979, U.S. inflation had reached 12 percent (Figure A.1.4.1). High
inflation reflected multiple one-time jumps in key prices and accommodative
demand policies that perpetuated high inflation. Oil prices rose seven-fold
between December 1972 and January 1974 and tripled again between
November 1978 and November 1979, amid supply disruptions around the
Iranian Revolution. From the 1960s, monetary policy was accommodative on
the understanding that permanently lower unemployment could be “bought”
with higher inflation—the standard understanding of the Phillips curve at the
time (Bryan 2018). The resulting accommodative monetary policy stance
combined with loose fiscal policy—for example, to finance the Vietnam War,
Great Society social spending, or the Kennedy tax cuts—to generate
considerable domestic demand pressures.
By the end of 1982, inflation had declined to below 4 percent, in part thanks to
an aggressive tightening of monetary policy, including a hike in the federal funds
rate from 11 percent in August 1979 to a peak of 19 percent in July 1981.1 In
1 In parts of advanced-economy Europe, central banks responded more strongly and earlier than in the
United States to rising inflation, but disinflation was also accompanied by output losses in the early 1980s
(Beyer et al. 2009; Söderström 2005; Miles et al. 2017; Berg et al. 2015; Nguyen et al. 2017).
FIGURE A.1.4.1 Macroeconomic developments during 1979-82

The U.S. disinflation from double-digits in August 1979 to inflation below 4 percent by end-
1982 was associated with two recessions (together termed the “Volcker recession”).
A. Inflation and unemployment rate B. Output growth and oil price
C. Output levels D. Federal funds rate and 10-year government

bond yields
Source: Haver Analytics.

A. Inflation is in year-on-year terms.
B. Output growth is in quarter-on-quarter seasonally adjusted annualized terms. Nominal oil price is in U.S. dollars
C. Chain-weighted real gross domestic product, seasonally adjusted and annualized, in billions of U.S. dollars at 2009
prices. Vertical lines and text show cumulative output losses between the troughs of the two recessions and the preceding
peaks.
October 1979, the Federal Reserve also overhauled its operations to switch from
targeting the federal funds rate to targeting nonborrowed reserves. Over the
same period, fiscal policy tightened by about 1 percentage point of gross
domestic product (Congressional Budget Office 2017). The disinflation was
associated with two recessions, together termed the “Volcker recession,” after the
Chairman of the Federal Reserve Board. In 6 of 12 quarters during 1980-82,
output contracted. The cumulative output losses during both recessions (peak
to trough) amounted to more than 2 percent. Unemployment rates doubled
from 6 percent in August 1979 to almost 12 percent at the end of 1982 (Figure
A.1.4.1).
Role of monetary policy in U.S. disinflation

The stagflation of the 1970s, as well as the recessions during 1979-82, have been
attributed to varying degrees to changes in monetary policy. For example,
Barsky and Kilian (2002) argue that the stagflation that preceded the 1979-82
recession was mostly attributable to excessively loose monetary policy,
compounded by oil price increases.
In particular, although the tripling of oil prices during 1978-79 is generally
recognized as the trigger of the recession, the monetary policy response to the oil
price spike deepened it. Bernanke, Gertler, and Watson (1997) showed that the
nonaccommodative monetary policy response to the oil price spike accounted
for its disproportionate effect on the economy. Rotemburg and Woodford
(1997) also found that unexpectedly tight monetary policy in early 1982
deepened the 1982 recession.2
The Federal Reserve’s switch in operational procedures allowed it to meet more
effectively its reserve money growth targets.3 The shift was followed by
considerable volatility and a sharp rise in the federal funds rate (Goodfriend
1983). It was eventually reversed by 1987 because of the instability of the
money demand function (Thornton 2004; Gilbert 1985).
Lessons from U.S. disinflation
The Great Inflation and the output losses during the subsequent disinflation
have helped transform the understanding of a central bank’s role. It is now
widely recognized that (i) monetary policy can only have short-term effects on
real output (that is, the Phillips curve changes over time); (ii) some monetary
policy rules are more stabilizing than others; and (iii) central bank credibility
that anchors inflation expectations is a critical precondition for effective
monetary policy.
Lack of long-term real-economy effects of monetary policy. During the 1970s,
monetary policy was guided by the Phillips curve, an empirical inverse
relationship between (wage) inflation and unemployment. This relationship
suggested that monetary policy could lower unemployment at the cost of higher
inflation. However, as central banks sought to exploit this relationship, it
became clear that the trade-off existed only in the short term: as inflation
expectations adjusted, the Phillips curve shifted, possibly in a nonlinear way
(Akerlof et al. 2000). Hence, the inflation-unemployment trade-off disappeared
2 In contrast, Uhlig (2005) argues that the role of monetary policy has been exaggerated by previous
authors’ methodology, in particular by imposing timing restrictions or the restriction of a negative

relationship between inflation and growth. When such restrictions are lifted, Uhlig (2005) finds that
monetary policy did not have a significant effect on growth during the Volcker recession.
3 In the previous operational procedures, money growth targets were achieved within some tolerance
bands by guiding the federal funds rate. Under the new procedures, money growth targets were achieved
by guiding nonborrowed reserves while maintaining the federal funds rate within a wide tolerance band
(Poole 1982).
over the long run. This meant that the persistent use of monetary policy to boost
employment and output beyond their long-run potential was fruitless and
simply raised inflation (Clarida, Gali, and Gertler 1999).
Switch to stabilizing monetary policy rules. The increasing awareness of central
banks’ inability to achieve a sustained improvement in output led to an
increased focus on monetary policy rules, in particular rules that emphasized the
goal of stabilization. Indeed, Dennis (2006) shows that there was large
uncertainty around estimated U.S. monetary policy rules before 1979 but,
thereafter, U.S. monetary policy could be modeled more precisely. Other studies
have also found evidence supporting a measurable change in U.S. monetary
policy rules. In a dynamic stochastic general equilibrium model, Bianchi (2013)
shows that the U.S. monetary policy regime switched from “dove” (favoring
output growth over disinflation) to “hawk” (vice versa) in the second half of
1980. Clarida, Gali, and Gertler (2000) demonstrate that the U.S. monetary
policy rule after 1979 responded more strongly to expected inflation than during
the preceding period. This new rule ensured greater macroeconomic stability
than earlier monetary policy rules. Owyang and Wall (2006) also document a
structural change between the pre-Volcker and Volcker-Greenspan eras in the
effect of monetary policy across U.S. regions.
Establishing central bank credibility. Bernanke, Gertler, and Watson (1997)
note that, by guiding expectations, the choice of a credible monetary policy is
key for macroeconomic stabilization. They acknowledge that econometric
models typically find a modest role (about 20 percent) for monetary policy
shocks—that is, unexpected monetary policy changes—in explaining output
movements. Blanchard (1984) demonstrates that a Phillips curve relationship
explained actual disinflation and output losses reasonably well until the end of
1981 but not thereafter. He interprets this as evidence that inflation expectations
initially remained unchanged from the Great Inflation, and the Federal Reserve
still lacked credibility.4 Research has also shown that the wrong monetary policy
rule can undermine central bank credibility. Barro and Gordon (1983a, 1983b)
demonstrate that rational households and investors will anticipate the behavior
of central banks that systematically attempt to reduce unemployment by surprise
monetary stimulus. To reduce unemployment, the central bank needs to
engineer ever-greater inflation surprises. Taking this into account, since
1979, the Fed’s monetary policy has arguably been guided by an informal
inflation targeting framework, even if its dual mandate was never abolished
(Goodfriend 2003).
4 With the benefit of more years of data, Alogoskoufis and Smith (1991) demonstrate the shift in the
Phillips curve during the Volcker recession.

Conclusion
The experience of the Great Inflation of 1965-82, stagflation in the 1970s, and
disinflation during 1979-82 transformed monetary policy in the United States
and the understanding of monetary policy more broadly. The Phillips curve is
no longer considered a useful policy tool, and instead it is recognized that a
credible central bank can reduce inflation with less output loss. As a result, “the
concept of credibility has become a central concern of the scholarly literature on
monetary policy” (Blinder 2000; Bordo and Orphanides 2013), and inflation
has become the “organizing focus of monetary policy” (Clarida, Gali, and
Gertler 2000).
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CHAPTER 2
Understanding Global Inflation Synchronization
Inflation movements have become increasingly synchronized internationally over

time: a common global factor accounts for about 22 percent of changes in national
annual inflation rates in the period since 2001. Inflation synchronization has also
become more broad-based: while it was previously much more pronounced among
advanced economies than among emerging market and developing economies, it has
become substantial in both groups over the past two decades. In addition, inflation
synchronization has become significant across all inflation measures since 2001,
whereas it was previously prominent only for inflation measures that included mostly
tradable goods. Greater inflation synchronization over time has coincided with
improvements in economic policy institutions in many countries, stronger global trade
linkages, and greater similarity of monetary policy frameworks that trigger similar
policy responses.
Introduction
Inflation has recently appeared to move in tandem among countries around the
globe. As documented in the previous chapter, inflation and inflation volatility
have trended downward in advanced economies since the mid-1980s and in
emerging market and developing economies (EMDEs) since the mid-1990s,
regardless of the price index examined. A wide range of structural factors have
contributed to declining inflation in recent decades. These factors appear to have
depressed inflation and changed the responsiveness of inflation to global and
domestic shocks.
This chapter expands on this analysis by exploring the extent to which global
and group-specific factors have driven movements in national inflation rates. A
growing number of studies provide evidence on highly synchronized national
inflation rates (Hakkio 2009; Cicarelli and Mojon 2010; Auer, Levchenko, and
Sauré 2017). Some of these also examine the extent of synchronization in other
real and nominal variables, in addition to inflation (Mumtaz, Simonelli, and
Surico 2011).
In theory, a wide range of factors could be responsible for the global

synchronization of inflation, such as common shocks, similar policy responses,
and structural features of economies, including openness to international trade
and financial flows. Early studies often highlighted the contribution of
Note: This chapter was prepared by Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge, and Filiz Unsal.
synchronized or coordinated monetary policies as a major source of inflation

comovement, especially among advanced economies (Clarida, Gali, and Gertler
2002; Rogoff 2003). More recent work has emphasized the roles of international
spillovers of technology and increased trade integration through global value
chains (Henriksen, Kydland, and Šustek 2013; Auer, Borio, and Filardo 2017).
This chapter expands empirical research on the topic by addressing the following
questions:
• How has inflation synchronization among countries evolved over the past
four to five decades?
• Which goods and price indexes have been associated with greater inflation
synchronization?
• What country characteristics have been associated with greater inflation
synchronization?
To answer these questions, the chapter examines synchronization in inflation
using a dynamic factor model that allows the estimation of latent global and
group-specific factors. In a unified framework, these factors capture
commonalities in multiple measures of inflation in a large, balanced sample of
countries (25 advanced economies and 74 EMDEs) over a long period (1970-
2017). The chapter makes four unique contributions to the literature.
First, it systematically explores the evolution of inflation synchronization among

many countries and over time. It identifies a truly global inflation factor that
captures common movements in inflation in a large sample of countries,
including many EMDEs. This contrasts with earlier studies that typically
included only advanced economies (Box 2.1). In this global sample, the evidence
of increased global inflation synchronization since 2001 is unambiguous,
whereas some earlier studies based on advanced economy samples have found no
such increase.
Second, in recognition of differences in economic structures and policy

frameworks between EMDEs and advanced economies, the model explicitly
allows for the role of an EMDE inflation factor that is distinct from an advanced
economy factor; the focus in the literature thus far has been on global factors.
Third, the chapter examines commonalities and differences in inflation

synchronization among a wide range of inflation measures. By choosing price
indexes that differ in their tradables content, this allows for a more precise
interpretation of the global factor and broadens the evidence for increased
inflation synchronization since 2001.
BOX 2.1 Global inflation synchronization: A review
This box summarizes the evidence in the literature that inflation has become
highly synchronized internationally over time. Global inflation synchronization
depends on the frequency of common shocks; the strength of cross-border
inflation spillovers, especially from major economies; the openness of economies
to international trade and financial flows; and the extent to which there are
similar policy frameworks among countries, generating similar policy responses.
It is therefore not surprising that there is evidence of an increase in inflation
synchronization in recent decades, since this has been a period of strengthening
global economic linkages, increasingly developed and internationally integrated
financial markets, and a growing prevalence of monetary policy frameworks
focused on the objective of low and stable inflation.
Using a wide range of methodologies, a large literature has studied various
aspects of inflation synchronization across countries and its evolution over
time. This box provides a brief summary of what this literature says on the
• How has global inflation synchronization evolved over time?
• Which factors have contributed to global inflation synchronization?
How has global inflation synchronization evolved?

Many studies have documented the high degree of inflation
synchronization in recent decades, mostly, but not exclusively, in advanced
economies.1 Some of these studies also report that the degree of
synchronization has increased over the past three decades.
Existence of a global inflation factor. Several studies have documented that
a global factor has accounted for a substantial proportion—ranging from
20 to 51 percent—of inflation variation among various groups of advanced
economies, with the estimated contribution differing somewhat by
inflation measure, time period, methodology, and sample composition
(Table A.2.1.1 in Annex 2.1). In a well-known study, Ciccarelli and Mojon
(2010) extract a common global factor from the consumer price index
(CPI) inflation of 22 Organisation for Economic Co-operation and
Development (OECD) countries over 1960-2008. They find that the
global factor accounts for almost 37 percent of the variance of national
1 The majority of studies on inflation synchronization employ variants of dynamic factor models
developed by Stock and Watson (1999); Forni et al. (2005); and Kose, Otrok, and Whiteman
(2003).
BOX 2.1 Global inflation synchronization: A review (continued)
inflation rates.2 Ferroni and

FIGURE 2.1.1 Contribution of Mojon (2014) update this
the global factor to inflation:
analysis through 2013, con-
Literature
firming a strong role for global
factors among advanced
The estimates of the contribution of the
global factor presented in this chapter economies.
are in the range of those reported
elsewhere in the literature, although at Hakkio (2009) extracts a global
the lower end of the range. factor from 19 OECD
countries’ inflation rates for
1960-2008 but adds a regional
factor
and expands the set of inflation
measures to include overall
CPI inflation, cyclical CPI
inflation, core CPI inflation,
and cyclical core CPI inflation.
He finds that the global factor
explains, on average, 41 percent
Source: Hakkio 2009; Ciccarelli and Mojon 2010;
Mumtaz, Simonelli, and Surico 2011; Neely and
of cyclical inflation variation.
Rapach 2011; Auer, Levchenko, and Sauré 2017; Auer, Levchenko, and Sauré
Parker 2018.
Note: Numbers in parentheses indicate the number of (2017) estimate a global
countries included. The figures for “This study,” for
consistency with other studies, shows the average inflation factor using a sample
contribution of the global factor to inflation variation.
A = annual data set; CPI = consumer price index;
of 30 countries and find that
PPI = producer price index; Q = quarterly data set. the global factor accounts for
51 percent of inflation
variation, half of which reflects common cost shocks propagated through
input-output linkages (see also Auer and Mehrotra 2014).
These studies use considerably smaller and more homogeneous country
samples than the sample used in this chapter. This helps to explain why, in
their studies, the global factors account for larger shares of inflation
variation (Figure 2.1.1). Nevertheless, the shares presented in this chapter
are within the range—although toward the low end—of those reported in
the literature.
2 Although they do not explicitly quantify the contribution of global factors to inflation
variation, Cecchetti et al. (2007) document coincident inflation developments around the world,
such as the widespread start of the Great Inflation in the late 1960s and synchronized inflation
stabilization in the mid-1980s.
Other studies estimate, typically in a Phillips curve framework, the impact

of specific global variables on domestic inflation—with mixed success. For
example, Eickmeier and Pijnenburg (2013), using data for 24 OECD
countries during 1980-2007, estimate a Phillips curve model of domestic
inflation using the global and idiosyncratic factors of output gaps and
changes in unit labor costs. They find that the global factor of changes in
unit labor costs has a notable impact on domestic inflation. Lodge and
Mikolajun (2016) also find that global commodity prices were important
determinants of inflation in 19 advanced economies, although other global
variables were not.
In related work, Borio and Filardo (2007) and Auer, Borio, and Filardo
(2017) show that global inflation and the foreign output gap add
explanatory power to conventional Phillips curve models of domestic
inflation for several OECD countries. However, Gerlach et al. (2008) find
that this result is not robust to the measurement of the global output gap,
controlling for additional variables, or the estimation period. Ihrig et al.
(2010) find that in estimates of the Phillips curve for 11 countries, the
globalization hypothesis has little support. Kabukçuoğlu and Martínez-
García (2018) model inflation expectations for 14 advanced economies in a
Phillips curve framework augmented by the global output gap and global
inflation. Their results for global output gaps are mixed—which they
attribute to measurement error—but the results still indicate a strong role
for global inflation in domestic inflation.
Evolution of global inflation synchronization over time. Neely and

Rapach (2011) extract a global factor and seven regional factors from CPI
inflation in 64 mostly advanced economies during 1950-2009. They find
that the global factor, on average, accounted for 35 percent of inflation
variance, and the regional factors accounted for 16 percent—and these
shares have risen substantially since the 1980s. Neely and Rapach (2011)
document that the regional (world) factor has increased in importance for
several North American and European (Latin American and Asian)
countries since 1980. Mumtaz and Surico (2012) estimate global and
regional factors from 164 inflation indicators for 13 OECD economies
during 1961-2004. They find that, in most countries, the degree of
inflation synchronization has strengthened since the 1980s. Mumtaz,
Simonelli, and Surico (2011) focus on an unbalanced panel of 36 countries
between 1860 and 2007. They show that the share of inflation variation
due to the global factor has grown since 1985.3
Which factors have contributed to global inflation

synchronization?
Several studies document strong economic policy institutions, trade
openness, and financial development as factors associated with a higher
degree of cross-country inflation synchronization. Two types of approaches
have been employed. First, the country characteristics associated with a
greater share of inflation explained by the global factor are analyzed.
Second, sectoral, goods, or subnational factor decompositions are used to
identify more granular patterns in inflation synchronization.
Country characteristics. Neely and Rapach (2011), in their sample of 64
mostly advanced economies during 1950-2009, correlate the share of CPI
inflation variance accounted for by the global factor with country
characteristics. They find that the share is higher in advanced economies
with stronger economic policy institutions, more developed financial
markets, lower inflation, and more independent central banks. Parker
(2018) shows that energy prices appear to be less synchronized with global
inflation factors in less developed economies. Ciccarelli and Mojon (2010)
document that the impact of a global inflation factor on domestic inflation
is stronger in countries with lower inflation. In a Phillips curve framework,
Auer, Levchenko, and Sauré (2017) present evidence that cross-border
trade in intermediate goods and services is the main channel through which
global economic slack influences domestic CPI inflation; cost shocks
propagated through input-output linkages account for about one-quarter of
inflation variability.
Sectoral decompositions. Monacelli and Sala (2009) estimate the
contributions of a global factor to inflation variance in a large cross-section
of sectoral price data (948 CPI products) for four OECD countries during
1991-2004. They find that, on average, the global factor explains 15-30
percent of the variation in disaggregated consumer price inflation, the share
being higher in sectors with greater trade openness. Förster and Tillmann
(2014) extract global, sectoral, and regional factors from CPI inflation in
3 Using wavelet analysis, Bhanja et al. (2013) and Bhanja, Dar, and Tiwari (2016) document that
inflation synchronization among Group of Seven and Euro Area countries has increased over time.
40 mostly OECD countries for 1996-2011.4 They find that about two-
thirds of overall inflation volatility is due to country-specific determinants.
For CPI inflation net of food and energy, the global factor and the CPI
basket-specific factor account for less than 20 percent of inflation variation.
Only energy price inflation in advanced economies is dominated by
common factors.
Parker (2018) extends Förster and Tillmann’s (2014) analysis to 223
countries and territories over 1980-2012. He finds that the global factor
explains around two-thirds of the variance of advanced economies’
inflation but only about one-fifth for middle-income countries and one-
tenth for low-income countries. Regardless of the country group, common
factors account for a larger share of variability in energy and food price
inflation than housing price inflation or, more broadly, headline CPI
inflation.
Subnational decompositions. Beck, Hubrich, and Marcellino (2009)
extract Euro Area, national, and subnational factors from subnational
inflation rates in six Euro Area countries. They find that the Euro Area
factor accounted for about half the inflation variation, and national and
regional components accounted for 32 and 18 percent, respectively.
Goods decompositions. Auer, Levchenko, and Sauré (2017) show, for
disaggregated producer price index (PPI) inflation for 30 mostly OECD
countries and 17 sectors during 1995 to 2011, that the global factor
explains nearly half the fluctuations in PPI inflation in the average
economy. They argue that this PPI synchronization across countries is
driven primarily by common sectoral shocks and amplified by input-
output linkages.
Conclusion
The literature has documented that inflation is highly synchronized
internationally, but that the degree of inflation synchronization varies with
country characteristics and other factors, including the measure of inflation
used. Findings have typically been restricted to headline CPI inflation,
largely disregarding sectoral differences in inflation synchronization.
4 Their novel dynamic hierarchical factor model allows a decomposition into a global factor, a
factor specific to a given subcomponent of the CPI (energy price inflation, food price inflation, and
CPI inflation net of food and energy items), a country-group factor driving the particular CPI
basket in industrial or emerging economies, and a country-specific component.
Fourth, the chapter studies a wide range of country characteristics that are
conducive to high inflation synchronization; the literature often confines itself to
only a few characteristics.
The chapter’s principal conclusions are as follows:
• In the median country, the global inflation factor accounted for one-eighth
(12 percent) of total variation in national inflation rates over 1970-2017. Its
contribution was much more pronounced in the median advanced economy
(24 percent) than in the median EMDE (10 percent) and negligible in the
median low-income country (LIC).
• The global factor’s contribution to inflation variation was greater between

1970 and 1985—a period of two global oil price spikes and two global
recessions—than between 1986 and 2000. Partly as a result of the 2008-09
global financial crisis and the 2014-16 oil price plunge, global inflation
synchronization strengthened significantly in 2001-17. During this last
period, the global factor explained 22 percent of national inflation in the
full sample. It accounted for 18 percent of inflation variation in the median
EMDE and 27 percent in the median advanced economy, compared with 7
and 22 percent, respectively, during 1986-2000. In LICs as well, the global
factor’s contribution increased to 17 percent in 2001-17 from a 3-4 percent
previously.
• In addition to global synchronization, group-specific inflation

synchronization has emerged among advanced economies and EMDEs. Like
global inflation synchronization, group-specific inflation synchronization
increased after 2000. Since 2001, the group-specific inflation factors have
accounted for 8 percent of inflation variation in the median EMDE, one-
third more than during 1986-2000, and for 21 percent in the median
advanced economy, one-sixth more than during 1986-2000.
• Global inflation synchronization has broadened across different measures of

inflation. In 1970-85, the extent of inflation synchronization was
pronounced only for inflation measures with a large portion of tradable
goods and services (import prices and producer prices); it has more recently
become sizable across all inflation measures. During 1970-2017, it was most
pronounced for the inflation measures with the largest share of tradables: it
was highest for import prices (54 percent), followed by the producer price
index (PPI), headline consumer price index (CPI), gross domestic product
(GDP) deflator, and core CPI (5 percent). Since 2001, it has grown to one-
third even for core CPI inflation and growth of the GDP deflator.
• Inflation synchronization has tended to be greater among countries with

higher trade openness, greater commodity-import intensity, and lower trade
concentration. Among EMDEs, the share of the global factor was

particularly high in East Asia and Pacific, Latin America and the Caribbean,
and South Asia. Since 2001, however, systematic differences in the role of
the global factor among countries with different characteristics have faded.
The next section documents the evolution of global and group-specific factors
that have driven the increased synchronization of inflation rates. The subsequent
section explores the synchronization across different measures of inflation,
including headline and core consumer price inflation, and measures based on
producer prices and import prices. The penultimate section examines the main
factors that explain the global synchronization of inflation. The final section
concludes with a brief summary, discussion of policy implications, and future
research directions.
Evolution of inflation synchronization

Using results from estimates of a dynamic factor model, this section documents
that global inflation synchronization has increased, in degree and breadth.
Data and methodology
The analysis is based on annual inflation data for 25 advanced economies and 74
EMDEs (including 16 LICs) for 1970-2017. In the benchmark estimation,
inflation is measured as annual headline CPI inflation. To analyze the extent of
synchronization in multiple measures of inflation, the database is augmented
with core CPI inflation, PPI inflation, import price inflation, and GDP deflator
growth for a subset of 38 countries (of which 13 are EMDEs) (Table A.2.1.2,
Annex 2.1).
A dynamic factor model is employed to decompose inflation in each country

into a global inflation factor that is shared across all countries, an advanced
economy or EMDE factor that is shared within the respective groups (that is,
two group-specific inflation factors), and an idiosyncratic inflation factor that is
unique to each individual country (see Annex 2.1 for details about the model
and estimation).1 Dynamic factor models are designed to extract a few
unobservable common elements from a large number of (observable) variables.
Thus, the model allows a parsimonious representation of the data in terms of the
unobservable common elements, which are typically referred to as factors. The
degree of global inflation synchronization is simply measured by the share of the
variance of national inflation attributable to the global factor. In a similar
1 These types of models are used extensively to analyze global business and financial cycles (Kose,
Otrok, and Whiteman 2008; Kose, Otrok, and Prasad 2012; Ha et al. 2017; Neely and Rapach 2011;
Mumtaz and Surico 2012).
fashion, the extent of inflation synchronization within each country group is

measured by the fraction of variance that is explained by the group-specific
factor.2
Inflation synchronization: Global and group factors
Behavior of the global and group-specific factors. The model identifies a global
inflation factor that, as expected, registers sharp movements around oil price
spikes and global recessions (Figure 2.1). Within a year of an average global
recession (such recessions having occurred in 1975, 1982, 1991, and 2009) and
during the average oil price plunge (these having occurred in 1986, 1990-91,
1997-98, 2001, 2008, and 2014-16), annual global inflation fell by 0.5 and 0.2
percentage point, respectively, below its long-term trend. Conversely, in the
average year preceding a global recession, global inflation was almost 2
percentage points above trend. The global factor moved in tandem with median
inflation across countries.3 The advanced economy and EMDE factors also
exhibited common (although more muted) movements with their respective
group-specific median inflation rates.
Importance of the global inflation factor. During 1970-2017, the global
inflation factor accounted for a sizable share of within-country inflation variance
in advanced economies and EMDEs (Figure 2.2; Table 2.1). In the median
country, the global factor accounted for 12 percent of inflation variation, but its
role varied widely across and within country groups (from near zero to 70
percent). For example, for the full sample period, the contribution of the global
inflation factor was much greater in the median advanced economy (24 percent)
than in the median EMDE (10 percent).
Importance of group-specific inflation factors. The group-specific factors have
also played an important role in driving inflation. For example, in the median
advanced economy, the group-specific factor accounted for 8 percent of inflation
variation during 1970-2017.
The contributions of the global inflation factor to inflation variation reported in
this chapter are consistent with, but at the low end of, the range of estimates
2 The results are qualitatively robust to different detrending methods (for example, the Hodrick-
Prescott or Butterworth filter), the use of a three-factor model (including country-specific factors), and
the use of quarterly data.
3 For 90 percent of the countries in the sample, the factor loadings on the global factor (coefficients
associated with the global factor in the model) are positive (and statistically significant within 90 percent
confidence intervals), indicating that national inflation rates generally move in tandem with the global
factor. The remaining 10 percent of the countries are mostly, although not exclusively, in Sub-Saharan
Africa (Algeria, Cameroon, Central African Republic, Democratic Republic of Congo, Gabon, Gambia,
Mali, Niger, Saudi Arabia, and Senegal). In these countries, the factor loadings on the global factor are
not statistically significantly different from zero.
FIGURE 2.1 Global and group inflation factors

The global factor troughs around global recessions and oil price plunges. The global factor
and, especially, the advanced-economy factor move in tandem with median inflation across
countries.
A. Global and group inflation factors B. Global factor and median global inflation
C. AE factor and median AE inflation D. EMDE factor and median EMDE inflation
Source: World Bank.

Note: The global and group inflation factors are estimated with the baseline dynamic factor model (two-factor model with a
global and a group-specific factor) for 1970-2017 (Annex 2.1). The sample includes 99 countries (25 AEs and 74 EMDEs,
including 16 low-income countries). “Median” denotes cross-country median headline inflation. AE = advanced economy;
EMDE = emerging market and developing economies.
A. Grey shades indicate periods of global recessions (1975, 1982, 1991, and 2009) and slowdowns (1998 and 2001); red
shades indicate periods of oil price plunges (1986, 1990-91, 1997-98, 2001, 2008, and 2014-16) (Kose and Terrones 2015;
Baffes et al. 2015). Identification of these global events is explained in more detail in Chapter 3.
reported in other studies (see Box 2.1). Earlier studies have reported that the
global inflation factor has contributed 20-50 percent to the variation in national
inflation rates, with estimates differing depending on the methodology, sample
periods, country groups, and data transformations. The differences in the
estimates presented here may reflect the more extensive inclusion of EMDEs in
the country sample in this study than in earlier work.
Evolution of inflation synchronization
Increasing synchronization over time. Global inflation synchronization has
risen over the past four to five decades (Figure 2.2; Table 2.2). This is illustrated
by estimates of the model for three approximately equal subperiods: 1970-85,
1986-2000, and 2001-17. The first period, 1970-85, overlaps with the Great
Inflation of 1965-84 (Annex 1.4 in Chapter 1); the second, 1986-2000, was a
FIGURE 2.2 Contributions of global and group factors to inflation

In the full sample period, 1970-2017, the global and group-specific inflation factors
together explain around 16 percent of the variation in inflation rates, but more in the median
advanced economy (32 percent) than in the median EMDE (13 percent). The share of
inflation variance explained by the global factor declined after 1985 but rose again after
2000. Since 2001, the global inflation factor has accounted for a larger share of inflation
variation in a greater number of countries than in the 1970s and 1980s.
A. All, advanced economies, and EMDEs B. Contributions of global and group factors
C. Contribution of global factor, 1980-85, D. Contribution of global factor, by number of

1986-2000, and 2001-17 countries
Source: World Bank.

Note: The contribution of global and group factors to inflation variance is estimated with the dynamic factor model over
1970-2017 and three subsample periods (Annex 2.1). The sample includes 99 countries (25 AEs and 74 EMDEs, including
16 low-income countries). AEs = advanced economies; EMDEs = emerging market and developing economies.
B.C. Unweighted means or medians.
TABLE 2.1 Variance decompositions: Headline CPI , 1970-2017

(percent)
Factor All countries Advanced economies EMDEs
11.9 24.3 10.4
Global
(18.8, 2.9 - 29.4) (25.6, 10.4 - 35.2) (16.4, 2.2 - 21.8)
3.9 8.1 2.1
Group
(11.6, 0.7 - 16.6) (12.7, 4.2 - 18.4) (11.3, 0.5 - 12.7)
27.2 37.2 21.4
Global + Group
(30.4, 14.0 - 44.2) (38.3, 30.6 - 49.6) (27.8, 11.5 - 41.8)
Note: All numbers indicate percent contributions of global and group-specific factors to the variance of headline CPI
inflation during 1970-2017. The contributions of global and group-specific inflation factors are estimated using the dynamic
factor model described in Annex 2.1. The data set includes 99 countries (25 advanced economies and 74 EMDEs). In each
pair of rows, the numbers in the first row indicate medians across countries. The first number in the second row (in
parentheses) is the unweighted mean across countries. The second and third numbers in the second row (in parentheses)
indicate the interquartile range (25th and 75th percentiles). CPI = consumer price index; EMDEs = emerging market and
developing economies.
period of widespread disinflation; and the third, 2001-17, was a period of low
but typically stable inflation (Chapter 1).
The global factor’s contribution to inflation variation was sizable—16 percent

for the median country in the full sample—in 1970-85, when economies were
considerably more energy-intensive than more recently and oil price spikes lifted
inflation globally (Baffes et al. 2015). Then, the global factor’s contribution
dipped to 10 percent during 1986-2000, as many countries implemented
policies to rein in inflation. But in 2001-17, it rose beyond its level in 1970-85,
to 22 percent for the median economy in the full sample and 18 percent for the
median EMDE; for the median advanced economy it rose to 27 percent but
remained below its level in 1970-85. Similarly, the contribution of the group
factor to inflation variation has grown since the 1970s and 1980s, to 21 percent
in the median advanced economy in 2001-17 (from 18 percent in 1970-85) and
8 percent in the median EMDE (from 6 percent).
Increasingly broad-based inflation synchronization. Global inflation

synchronization has become more broad-based over time. During 1986-2000,
for example, the global factor contributed more than 10 percent to inflation
variation in around one-third of the countries in the sample (compared with half
the countries in 1970-85), and during 2001-17, this was the case in two-thirds
of the countries. The distribution of the contribution of the global factor has
clearly shifted to the right between 1970-85 and 2001-17 for all country groups
(Figure 2.2). The distribution of the contribution of the group factor to inflation
variation only shifted to the right for advanced economies: for EMDEs, the
distribution in 2001-17 resembled that in 1970-85.4
Inflation synchronization in LICs. Until 2000, the contribution of the
global factor to inflation variation in LICs was negligible (3-4 percent in the
median LIC). Since 2001, however, the global factor’s contribution has
quintupled to 17 percent in the median LIC, a level broadly in line with the
median EMDE. The share of LICs with a contribution of the global factor
to inflation variation in excess of 10 percent has risen from one-quarter
before 2000 to two-thirds since 2001. In addition to the growing
contribution of the common global factor to short-term inflation
movements, global factors have also contributed considerably to long-term
inflation movements. Chapter 6 documents that a benign external environment
was the main reason for the decline in trend inflation in LICs over the past two
4 These trends are robust to estimating the dynamic factor model by subsample periods of 15-year
rolling windows. The combined importance of global and group-specific factors declined until 2006, but
it has since increased again. The share of variance due to the global factor was often higher for rolling
samples that overlapped with the post-2007 period, reflecting the highly synchronized movements in
inflation across countries following the global financial crisis.
TABLE 2.2 Variance decompositions, over time: Headline CPI

(percent)
1970-2017 1970-85 1986-2000 2001-17
Factor All countries
11.9 15.5 9.9 22.1
Global
(18.8, 2.9 - 29.4) (25.8, 4.1 - 40.1) (16.2, 1.5 - 29.0) (20.7, 8.6 - 30.9)
3.9 7.9 6.7 9.0
Group
(11.6, 0.7 - 16.6) (12.2, 2.3 - 18.2) (19.4, 2.8 - 22.0) (13.7, 3.8 -19.5)
27.2 31.0 34.8 33.6
Global + Group
(30.4, 14.0 - 44.2) (38.0, 18.3 - 59.5) (35.6, 16.1 - 48.7) (34.4, 19.0 - 49.3)
Factor Advanced economies
24.3 31.6 22.0 27.3
Global
(25.6, 10.4 - 35.2) (30.8, 10.8 - 39.7) (22.9, 9.9 - 35.5) (26.1, 21.6 - 32.9)
8.1 18.0 15.7 20.5
Group
(12.7, 4.2 - 18.4) (18.1, 7.3 - 24.0) (21.0, 4.9 - 33.6) (22.7, 9.4 - 34.8)
37.2 47.2 45.0 50.7
Global + Group
(38.3, 30.6 - 49.6) (48.8, 36.3 - 64.6) (43.9, 26.9 - 55.4) (48.8, 39.1 - 62.8)
Factor EMDEs
10.4 13.6 6.6 18.1
Global
(16.4, 2.2 - 21.8) (24.1, 2.9 - 38.9) (14.0, 0.7 - 26.7) (18.9, 5.8 - 30.3)
2.1 6.3 6.4 7.8
Group
(11.3, 0.5 - 12.7) (10.3, 1.9 - 15.1) (18.9, 2.7 - 19.0) (10.7, 3.2 - 16.9)
21.4 25.8 27.4 28.9
Global + Group
(27.8, 11.5 - 41.7) (34.4, 13.8 - 52.3) (32.9, 13.0 - 43.8) (29.6, 17.2 - 39.4)
Note: All numbers indicate percentage contributions of the global and group-specific factors to the variance of headline CPI
inflation. The contributions of global and group-specific inflation factors are estimated using the dynamic factor model
described in Annex 2.1. The data set includes 99 countries (25 advanced economies and 74 EMDEs). In each pair of rows,
the numbers in the first row indicate medians across countries. The first number in the second row (in parentheses) is
the unweighted mean across countries. The second and third numbers in the second row (in parentheses) indicate the
interquartile range (25th and 75th percentiles). CPI = consumer price index; EMDEs = emerging market and developing
economies.
decades. Growing synchronization coincided with LICs’ rapid integration into

global trade networks as well as a shift toward greater exchange rate flexibility
(Box 1.2, Chapter 1).
Extent of synchronization: Inflation and output

How high is the degree of global inflation synchronization reported here relative
to the synchronization of other, comparable economic variables? To answer this
question, it is useful to compare the extent of inflation synchronization with
that of business cycles. A large literature reports that there is a global business
cycle, evidenced by a high degree of synchronization of various measures of
national economic activity, including output growth.
Inflation tends to exhibit stronger global synchronization than output growth

(Box 2.2). For the full sample of countries over 1970-2017, the median
contributions of the global factor to variations in inflation and output growth
were 12 and 5 percent, respectively. The difference was somewhat more
pronounced for EMDEs than for advanced economies. The global factor
accounted for 10 percent of inflation variation in the median EMDE but only 3
percent of output growth variation. In the median advanced economy, the
contribution of the global factor was also more sizable for variations in inflation
(24 percent) than in output growth (19 percent). Since 2001, the median
contributions of the global factor to variation in inflation and output growth
have increased significantly, to 22 and 12 percent, respectively, for the full
sample of countries.
Synchronization across different measures

of inflation
The inflation synchronization discussed thus far refers to headline CPI inflation.
However, the degree of inflation synchronization differs across various measures
of inflation. To analyze these differences, a dynamic factor model is estimated
using five measures of inflation with varying tradables content (headline CPI,
core CPI, PPI, GDP deflator, and import prices).5 Separately, a common factor
to represent nontradables inflation is extracted from the three measures with
below-average tradables content (core CPI, headline CPI, and GDP deflator),
and a common factor to represent tradables inflation is extracted from the three
measures with above-average tradables content (import prices, headline CPI, and
PPI). Global and group-specific factors for each inflation measure are estimated
separately for annual data for 38 countries (25 advanced economies and 13
EMDEs) over 1970-2016.
Inflation synchronization: Different measures

Behavior of global inflation measures. Global factors were typically more
volatile for inflation measures with greater tradables content.
• Global factors for PPI and import price inflation tended to move together
over the past four to five decades, but with considerably greater variability in
the global factor for import price inflation—as may be expected for goods
5 In price indexes for the United States, for example, the share of tradable goods and services is greatest
for the PPI (54 percent), followed by headline CPI (53 percent), GDP deflator (26 percent), and core CPI
(15 percent), according to the U.S. Bureau of Labor Statistics. The classification of sectors into tradables
and nontradables here follows the earlier literature: agriculture, hunting, forestry and fishing, mining and
quarrying, and manufacturing are classified as tradable sectors and the rest as nontradable (Knight and
Johnson 1997).
BOX 2.2 Global synchronization of inflation and output growth
International synchronization of inflation has tended to be higher than that of

output growth over the past four to five decades. This result is mainly driven by
the much higher degree of inflation synchronization during 1970-85, which
witnessed multiple common shocks. Over the past three decades, the degree of
synchronization of output growth has increased to become comparable to that of
inflation. The differences in the degree of synchronization in inflation and
output growth over time may reflect changes in the nature and frequency of
global shocks and structural factors, including the evolution of policy
frameworks.
Relative to what is the degree of international inflation synchronization

reported in this chapter “high”? A comparison with the extent of business
cycle synchronization offers a possible standard of reference for this
question. A large literature reports the degree of international
synchronization of various measures of business cycles, including output
growth. This box examines the evidence on the relative degrees of
synchronization of inflation and output growth to address the following
questions:
• How does the degree of synchronization of inflation compare with

that of output growth?
• What are the major factors that could explain the difference between
the extent of synchronization of inflation and output growth?
Inflation versus output synchronization
Full sample comparison. To examine the relative degrees of synchro-

nization in output growth and inflation, global factors for the two variables
were separately estimated using the baseline two-factor model for 99
countries over 1970-2017. Inflation movements tended to exhibit a
stronger degree of synchronization than output growth (Figure 2.2.1).1
Specifically, the median contributions of the global factors to variation in
inflation and output growth for the full country sample in this period are
1 This is consistent with the findings in earlier theoretical and empirical studies (Henriksen,
Kydland, and Šustek 2013; Mumtaz, Simonelli, and Surico 2011; Wang and Wen 2007). For
instance, Wang and Wen (2007) offer sticky-price and sticky-information New Keynesian models
to explain inflation synchronization that is high and well in excess of output synchronization;
neither model can account for the phenomenon. They conclude that neither nominal rigidities nor
monetary shocks are likely sources of inflation synchronization.

(continued)
12 and 5 percent, respectively. The difference reflects weak output growth

synchronization in advanced economies and emerging market and
developing economies (EMDEs): the global factor accounted for 10
percent of inflation variation in the median EMDE but only 3 percent of
output growth variation. In contrast, in the median advanced economy,
the contribution of the global factor was sizable for variations in inflation
(24 percent) and output growth (19 percent). These results are consistent
with findings in earlier studies.2
Inflation and output synchronization over time. Over the past three
decades, the degree of synchronization of output growth has grown to
become comparable to that for inflation (Figure 2.2.1). During 1970-85,
inflation synchronization (with a median variance contribution of the
global factor of 16 percent) was stronger than output growth
synchronization (5 percent). During 1986-2000, however, the median
share of the global factor in the variance of inflation declined to 10
percent, and the share of the global output growth factor remained low (6
percent), with wide differences across countries. Since 2001, the median
contribution of the global factor to variation in output growth and
inflation have increased significantly, to 12 and 22 percent, respectively.
For the median advanced economy, the share is now greater for output
growth (34 percent) than for inflation (27 percent). For the median
EMDE, the global factor still contributed more to inflation variation (18
percent) than to output growth variation (7 percent).
The trends in the relative importance of global and group-specific factors

over time were similar for output growth and inflation. Output growth
and inflation were explained more by global factors than group-specific
factors during 1970-85, but the relative importance of the group-specific
factors increased during 1986-2000.3 However, since 2001, the global
factors have again become more important than the group-specific factors
for output growth and inflation. Although these trends were similar in
direction, they were more pronounced for inflation than for output
growth.
2 For example, among 60 mostly advanced economies, the global factor accounts for 25-50
percent of the variance of output growth (Kose, Otrok, and Whiteman 2003).
3 This is consistent with the findings on the “decoupling of macroeconomic variables between
advanced economies and EMDEs” reported by Kose, Otrok, and Prasad (2012).

(continued)
FIGURE 2.2.1 Synchronization in output growth and inflation

Global inflation synchronization has been stronger than global synchronization
of output growth, especially in EMDEs. In advanced economies, inflation
synchronization has been comparable to, or lower than, output growth
synchronization since the mid-1980s.
A. Contribution of the global factor to B. Contribution of the global factor to

output growth and inflation variation, output growth and inflation variation,
1970-2017 over time
C. Contribution of the global factor to D. Contribution of the global factor to

output growth and inflation variation: output growth and inflation variation:
Advanced economies EMDEs
E. Contribution of global and group F. Contribution of global and group

factors to output and inflation variation, factors to output and inflation variation,
over time by country group
Source: World Bank.

Note: Contribution of global and group factors to the variance of real output growth and inflation in 99
economies (25 AEs and 74 EMDEs, including 16 low-income countries), based on a two-factor dynamic
factor model (Annex 2.1). AEs = advanced economies; EMDEs = emerging market and developing
economies; GDP = gross domestic product.

(continued)
Evolution of global factors for output growth and inflation. Around the
global oil price spikes in the 1970s and the oil price plunge in the mid-
2010s, global (and group-specific) factors for output growth and inflation
moved in opposite directions, possibly indicating a major role of global
supply shocks as the main drivers of global business and inflation cycles
during these episodes. However, around global recessions and slowdowns,
especially around the global financial crisis in 2008-09, the two global
factors moved in tandem, probably due to demand shocks. This time-
varying correlation between the two global factors is clearly observed for
EMDE-specific factors (Figure 2.2.2).
Reasons for differences in inflation and output growth

synchronization
Henriksen, Kydland, and Šustek (2013) examine this question in an

international business cycle model with common technology shocks as well
as cross-border technology spillovers. In their model, central banks’ policy
rules are combined with a no-arbitrage condition between domestic and
foreign interest rates to render current prices (and interest rates) a function
of expected future output. This results in a stronger cross-country
correlation in prices than in output.
Alternatively, the difference in the degrees of synchronization may reflect

the nature of global shocks or differential impacts of cross-border spillovers
of shocks on inflation and output. If movements in the prices of
internationally traded goods, such as swings in commodity prices, play an
important role as global shocks, their impact on inflation could be greater
and more immediate than their impact on output. Indeed, the degree of
inflation synchronization is much higher than that of output growth
during 1970-85, a period that witnessed multiple global shocks associated
with sharp movements in oil prices.
Considering that cross-border spillovers of shocks can drive global

synchronization in inflation and output, structural changes can also
influence real and nominal linkages across countries. For instance, the
strong degree of output synchronization among advanced economies
during 2001-17, which was slightly more pronounced than inflation
synchronization during the same period, might partly reflect widespread
and major economic disruptions during the global financial crisis.

(continued)
FIGURE 2.2.2 Global inflation and output growth factors

Around global recessions and slowdowns, especially around the global
financial crisis in 2008-09, global inflation and output growth factors moved in
tandem, probably due to demand shocks.
A. Global factors for output growth and B. EMDE factors for output growth and
inflation inflation
Source: World Bank.

Note: The global and group inflation and output growth factors are estimated with the baseline dynamic
factor model (two-factor model with a global and a group-specific factor) for 1970-2017 (Annex 2.1). The
sample includes 99 countries (25 advanced economies and 74 EMDEs, including 16 low-income
countries). Grey shades indicate the periods of global recessions and slowdowns (Kose and Terrones
2015). EMDEs = emerging market and developing economies; GDP = gross domestic product.
Conclusion
Is the degree of inflation synchronization reported in this chapter “high”?
A comparison with output growth synchronization suggests that the
answer is a qualified yes. Since 1970, global inflation synchronization has
been more than twice as large as global output synchronization. The
difference may reflect a multitude of shocks to internationally traded
prices, which affected domestic inflation more directly than output, or
technology spillovers that affected prices more than output because central
banks responded proactively to the shocks. Over time, inflation and output
synchronization have risen.
prices that are heavily exposed to, if not determined in, global markets
(Figure 2.3). During global recessions and episodes of large oil price swings,
the global PPI and import price factors exhibited sharper movements than
the global headline CPI factor. With a larger share of nontradable goods and
services prices in the GDP deflator, the global factor for this measure has
been considerably less volatile than those for headline CPI, PPI, and import
price inflation.
FIGURE 2.3 Global inflation factors: Various inflation measures

Global factors for PPI and import price inflation have tended to move together over the past
four to five decades, and they have been considerably more volatile than the global factor
for headline CPI inflation. With a larger share of nontradable goods and services prices in
the GDP deflator, the contribution of the global factor to variations in GDP deflator growth
has been smaller and considerably less volatile than those for PPI and import price
inflation. The contribution of the global factor to core CPI inflation variation—which contains
the largest share of nontradable goods and services among the inflation measures used
here—has been the smallest among various inflation measures.
A. Global factors: Headline CPI, PPI, and B. Global factors: Headline CPI, core CPI, and
import price GDP deflator
C. Contribution of global and group-specific D. Correlations of headline and core CPI

factors to inflation variation: Various inflation factors with other global factors
measures
Source: World Bank.

Note: The global and group inflation factors are estimated with a baseline dynamic factor model (two-factor model) using
detrended inflation rates in 38 countries (25 advanced economies and 13 EMDEs) for 1970-2016. CORE = core CPI;
CPI = headline consumer price index; DEF = GDP deflator; GDP = gross domestic product; IMP = import prices;
• Since the mid-1980s, the global factor for core CPI inflation—which
contains the largest share of nontradable goods and services among the
inflation measures examined here—has been less volatile than those for the
other inflation measures. This may reflect the exclusion of energy prices
(which tend to comove globally), as well as strengthened monetary policy
frameworks and better-anchored inflation expectations, as a growing
number of central banks succeeded in lowering inflation from high levels
and began to employ inflation-targeting frameworks (as discussed in
Chapters 1 and 4). The decoupling of core inflation from other inflation
measures was also reflected in declining correlations between the global

factors for core CPI and other measures of inflation. Thus, the correlation of
the global factor for core CPI inflation with that for import price inflation
halved between 1970-85 (0.8) and 2001-16 (0.4), while the correlation of
PPI or headline CPI inflation with import price inflation remained high, at
around 0.7-0.9.
Contribution of global factors to inflation variation. The estimated global
factor’s contribution to inflation variation was higher in inflation measures with
greater tradable goods and services content (Figure 2.3; Table 2.3). For example,
the global factor’s contribution to inflation variation was largest for import
prices (54 percent in the median country) and smallest for core CPI inflation (5
percent). Between these two extremes, the global factor’s contribution to
variation in PPI inflation was 42 percent and that to GDP deflator growth was
on the order of 13 percent, which was comparable to that for headline CPI
inflation.
Contribution of the group-specific factor to inflation variation. In contrast to
the results for the global factor, the group-specific inflation factor contributed
more to variation in inflation measures with less tradables content: it was largest
for the core CPI, followed by the GDP deflator, headline CPI, PPI, and import
prices. The median contribution of the group-specific factor to the variation in
core CPI inflation was 14 percent—considerably more than that of the global
factor (5 percent). For GDP deflator growth, the median contributions of the
global and group-specific factors were similar, at 13 and 12 percent, respectively.
For import prices and PPI, the contributions of the group-specific factors were
negligible (less than 5 percent).
Evolution of inflation synchronization: Different measures
Trends in inflation synchronization over time were similar across the five
inflation measures (Figure 2.4; Table A.2.1.3). During 1970-85, the role of the
global inflation factor was sizable for all five inflation measures except core CPI
inflation; global inflation synchronization weakened during 1986-2000, but
returned in the 2000s to levels similar to those of 1970-85. During 1970-85, the
median contribution of the global inflation factor was 68 percent for inflation
variation in import prices, followed by PPI (52 percent) and core CPI (8
percent).
During 1970-85, the contribution of the global factor to inflation variation was
much greater than that of the group-specific factor for all inflation measures
except core CPI inflation. During 1986-2000, however, the global factor’s
contribution fell below 10 percent for all five measures, and the contribution of
TABLE 2.3 Variance decompositions: Various inflation measures (percent)
Import prices PPI Headline CPI GDP deflator Core CPI

54.4 42.1 15.7 12.6 4.7
Global
(51.8, 45.6-66.1) (41.1, 15.3-61.7) (22.9, 6.2-36.5) (18.7, 3.2-30.5) (12.5, 1.7-15.4)
2.1 3.2 9.1 12.1 14.1
Group
(8.5, 1.1-15.1) (6.6, 0.9-8.8) (12.8, 3.4-21.4) (16.0, 4.6-25.5) (18.8, 2.9-26.6)
63.2 49.9 34.1 35.3 26.3
Global + Group
(60.4, 51.5-70.4) (45.2, 19.7-67.3) (35.7, 25.4-44.6) (33.8, 19.1-45.0) (27.2, 10.9-40.4)
54.4 56.1 21.4 13.4 7.9
Global
(52.7, 45.6-66.1) (48.4, 33.9-63.7) (23.7, 11.0-36.6) (19.1, 6.5-31.5) (15.5, 3.1-21.4)
2.5 4.5 11.5 12.6 17.7
Group
(7.5, 1.4-15.1) (7.7, 1.1-9.6) (14.0, 4.1- 24.1) (15.9, 3.5- 25.0) (21.9, 8.7-34.8)
63.2 60.6 35.9 37.3 34.3
Global + Group
(60.2, 49.5-72.5) (51.6, 31.2-68.1) (37.7, 31.1-44.8) (33.6, 18.1- 45.8) (33.5, 18.9-46.4)
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
Factor EMDEs
56.9 16.2 11.6 9.3 1.7
Global
(48.2, 40.2-64.9) (28.3, 11.1-40.4) (21.4, 3.4-36.3) (18.0, 2.2-26.1) (8.0, 1.3-9.1)
1.0 1.4 7.7 9.5 2.9
Group
(12.8, 0.7-13.1) (4.7, 0.8-4.0) (10.4, 0.9- 11.8) (16.2, 6.2- 25.5) (11.5, 1.5-13.5)
61.4 22.6 25.6 33.7 11.8
Global + Group
(61.1, 57.0-65.5) (33.0, 13.5-41.0) (31.9, 16.7-43.9) (34.2, 22.2-37.4) (15.0, 3.0-16.5)
Note: The contributions of global and group inflation factors to inflation variance are estimated with a two-factor dynamic factor model for each of the five different inflation measures: Import prices, PPI,
headline CPI, GDP deflator, and core CPI (Annex 2.1). The sample includes 38 countries (25 advanced economies and 13 EMDEs), except for import prices, which are only available for 21 countries (17
CHAPTER 2
advanced economies and 4 EMDEs). In each pair of rows, the first number in the first row indicates medians across countries. The first number in the second row (in parentheses) is the unweighted mean
variance share across countries. The second and third numbers in the second row (in parentheses) indicate the interquartile range (25th and 75th percentiles). The results for headline inflation may differ
from Tables 2.1 and 2.2 because of a smaller sample size, to match the sample with available data for other measures of inflation. CPI = consumer price index; EMDEs = emerging market and developing
economies; GDP = gross domestic product; PPI = producer price index.
115
FIGURE 2.4 Contribution of global and group factors to inflation over

time: Various inflation measures
Across all measures of inflation, global inflation synchronization decreased in the mid-
1980s and 1990s before rising again in the 2000s.
A. IMP, PPI, and CPI B. CPI, CORE, and DEF
Source: Haver Analytics; OECD; World Bank.

Note: The global and group inflation factors are estimated with a dynamic factor model using annual inflation in 38
countries (25 advanced economies and 13 EMDEs) for 1970-2016 (Annex 2.1). CORE = core consumer price index;
CPI = headline consumer price index; DEF = GDP deflator; IMP = import prices; PPI = producer price index.
the group-specific factor rose to match or even exceed that of the global factor
for virtually all inflation measures. Since 2001, the contribution of the global
inflation factor has risen to around two-thirds for PPI inflation variation and
around one-third for core CPI inflation and GDP deflator growth variation.
Inflation synchronization: Tradable versus nontradable

goods and services
Similar results are obtained from an exercise that extracts separate global and
group-specific factors for mainly tradables (headline CPI, PPI, and import
prices) and mainly nontradables (headline CPI, GDP deflator, and core CPI)
inflation measures.6 The global factor accounted for a much larger share of
tradables inflation (40 percent) than nontradables inflation variation (13
percent) (Figure 2.5; Table 2.4). The median contribution of the group-specific
factor to inflation variation was similarly low for the nontradables sector as for
the tradables sector (6 percent). The differences between the contributions of
global and group-specific factors to tradables and nontradables inflation were
larger for advanced economies than for EMDEs.
Sources of inflation synchronization

A wide range of factors could be responsible for the global synchronization of
inflation. This section starts with a brief conceptual discussion of three broad
6 The results are robust to the exclusion of headline CPI from the estimation of the global factor for
the nontradables sector.

FIGURE 2.5 Global and group inflation factors: Tradables and

nontradables
Global inflation factors for tradable and nontradable goods moved broadly together until
the late 1990s when the nontradables factor stabilized while the tradables factor did not.
The share of inflation variance explained by the global inflation factor is greater for tradable
goods than nontradable goods and larger for advanced economies than for EMDEs. Group
-specific inflation synchronization is stronger for nontradable goods and services than for
tradables.
A. Global inflation factors: Tradables and B. AE-specific inflation factors: Tradables and
nontradables inflation nontradables inflation
C. EMDE-specific inflation factors: Tradables D. Contributions of global and group factors

and nontradables inflation to tradables and nontradables inflation
variation
Source: World Bank.

Note: The global and group inflation factors for tradable and nontradable goods are estimated with a two-factor dynamic
factor model for 1970-2016 (Annex 2.1). The common factor from three measures for domestic inflation (import prices,
PPI, and headline CPI) is used as a proxy variable for the common component for tradable goods. Similarly, common
factors for headline CPI, core CPI, and the GDP deflator are extracted as a proxy for global inflation factor for nontradable
goods. The data are detrended annual inflation for 25 AEs and 13 EMDEs for 1970-2016. AEs = advanced economies;
CPI = consumer price index; EMDEs = emerging market and developing economies; GDP = gross domestic product;
factors that could explain inflation synchronization: shocks, policy responses,

and structural changes. This discussion is followed by an analysis of country-
specific structural and policy-related features that correlate with inflation
synchronization.
Shocks. Inflation synchronization across countries could be driven by common

shocks that spread evenly (or at least simultaneously) across countries, and/or by
TABLE 2.4 Variance decompositions: Tradables and nontradables

(percent)
Nontradable sector Tradable sector
13.2 40.1
Global
(19.3, 4.3 - 31.6) (36.7, 14.5 - 53.6)
5.9 3.8
Group
(10.9, 0.7 - 15.4) (7.2, 1.7 - 9.8)
30.2 45.7
Global + Group
(30.2, 13.3 - 41.8) (43.9, 24.1 - 62.8)
17.9 43.4
Global
(21.5, 9.3 - 32.1) (41.7, 29.7 - 55.2)
9.4 3.9
Group
(11.3, 2.8 - 16.6) (7.4, 1.3 - 10.1)
33.7 52.4
Global + Group
(32.8, 20.0 - 43.3) (49.0, 34.4 - 63.7)
Factor EMDEs
7.8 15.3
Global
(15.2, 2.5 - 21.0) (25.6, 8.6 - 40.4)
1.2 3.4
Group
(10.0, 0.2 - 8.5) (6.7, 1.9 - 7.1)
13.3 24.1
Global + Group
(25.2, 8.7 - 39.8) (32.3, 12.7 - 52.4)
Note: The global and group inflation factors for tradable and nontradable goods and services are estimated with the
baseline two-factor dynamic factor model for 1970-2016 (Annex 2.1). The common factor from three measures of domestic
inflation (import prices, PPI, and headline CPI) is used as a proxy variable for the common component for tradable goods.
Similarly, common factors for headline CPI, core CPI, and the GDP deflator are extracted as a proxy for the global inflation
factor for nontradable goods. The sample includes annual inflation in 38 countries (25 advanced economies and 13
EMDEs) for 1970-2016. The long-term trend (15-year moving average) is eliminated from annual inflation rates. For each
pair of rows, the number in the first row indicates medians across countries. The first number in the second row (in
parentheses) is the unweighted mean across countries. The second and third numbers in the second row (in parentheses)
indicate the interquantile range (25th and 75th percentiles). CPI = consumer price index; EMDEs = emerging market and
country-specific shocks that spill over from one country or a subset of countries
to others. Commodity price shocks, internationally correlated productivity
shocks, other cost-push shocks, and real demand shocks that trigger global
recessions or expansions could all affect national inflation rates widely and often
in the same direction, which would represent inflation synchronization. For
example, the 2009 global recession was followed by a prolonged period of
globally depressed inflation. Other shocks could affect countries asymmetrically.
For example, oil price shocks would affect oil importers and oil exporters
differently (Baffes et al. 2015).
Similarly, a recession in a relatively large economy could have greater spillover

effects on activity and inflation in its close trading partners than elsewhere
(Huidrom, Kose, and Ohnsorge 2017). Exchange rate changes, especially ones
that go beyond movements warranted by real-economy developments, such as

domestic currency crises or confidence shocks, will also tend to pass through
into national inflation rates asymmetrically (Shambaugh 2008). On average,
traded goods account for over 60 percent of consumer baskets in EMDEs and
47 percent of consumer baskets in advanced economies. Hence, exchange rate
movements would tend to affect consumer prices directly and significantly. The
extent of such exchange rate pass-through is discussed in detail in Chapter 5.
Similar policy responses. Earlier studies have often highlighted the contribution
of correlated or coordinated monetary policies as a main source of inflation
comovement, especially among advanced economies (Clarida, Gali, and Gertler
2002; Rogoff 2003). Even if there is no deliberate coordination of policies,
similar monetary policy frameworks can trigger similar policy responses to global
shocks. This policy synchronicity would then translate into inflation
synchronicity.
For example, a growing number of countries have introduced inflation targeting
monetary policy frameworks. In many of these countries, inflation targets have
been lowered over the past three decades, and in advanced economies the targets
are now virtually universally at or around 2 percent (Chapter 1). In EMDEs,
inflation targeting has been associated with lower inflation, and the switch to
inflation targeting has been associated with larger declines in inflation (Fang,
Miller, and Lee 2012; Gonçalves and Salles 2008). Henriksen, Kydland, and
Šustek (2013) develop an international business cycle model with technological
spillovers in which central banks’ Taylor rules trigger monetary policy responses
to productivity shocks that are similar across countries. As a result, their model
generates movements in inflation that are synchronized across countries.
Structural changes. Over the past four to five decades, the degree of global
integration in trade and financial markets has grown rapidly (Chapter 1). These
structural changes have often strengthened cross-country spillovers of real and
nominal shocks, which have in turn led to more synchronized movements in
inflation.
• Stronger trade linkages increase an economy’s exposure to external shocks.
With growing trade linkages, import prices have accounted for rising shares
of global production costs and domestic prices of final goods and services.
As a result, domestic inflation has become more sensitive to global shocks
7 This study is broadly in line with the literature that investigates the role of international input-output
linkages in driving the synchronization of global business cycles (Kose and Yi 2006; di Giovanni and
Levchenko 2010; Johnson 2014). Martínez-García (2015) develops a new open-economy macro model
for the United States and 38 of its trading partners. The model can account for inflation synchronization
even in the absence of common shocks, simply through the presence of strong spillovers associated with
trade linkages.
that raise or lower import prices (Bianchi and Civelli 2015).7 The results in
the previous section indicate that inflation synchronization has been greater
for measures with larger tradables content and, since 2001, has increased
across inflation measures. These findings likely reflect that prices are more
likely to be internationally determined in sectors with strong trade linkages
to global markets where they are subject to common demand and supply
shocks (Karagedikli, Mumtaz, and Tanaka 2010; Parker 2018). Over time,
the impact of global shocks in traded goods prices tend to be passed through
to other prices, with the degree and speed of the pass-through depending on
country characteristics, including trade and financial openness and the
credibility of the central bank’s inflation objective (Chapter 5).
• Rapidly expanding global supply chains allow global supply and demand
shocks as well as commodity price swings to ripple through global input-
output linkages and global labor markets and cause comovement in national
inflation rates (Rogoff 2003; Auer, Borio, and Filardo 2017).
• Greater international competition has made domestic inflation less sensitive to
domestic output gaps, flattening Phillips curves (Eickmeier and Pijnenburg
2013; Carney 2017; Kabukçuoğlu and Martínez-García 2018).
• Financial linkages. Increased international integration of financial markets
has been accompanied by greater synchronization of financial conditions—
including financial stress—across countries (Neely and Rapach 2011;
Carney 2017). As financial stress spreads (or recedes) across global financial
markets, it tightens (or loosens) credit and financial conditions in a wide
range of countries. As a result, movements in domestic demand and
disinflationary or inflationary pressures are also synchronized across
countries.
• Technological changes, in addition to deepening supply chains, can also help
globalize markets for nontradable service sectors. This may extend and
deepen the impact of global forces on domestic inflation (Henriksen,
Kydland, and Šustek 2013; Carney 2017).
Country-specific features
The results in the previous sections indicate that, since 2001, the global factor
has accounted for 27 percent of domestic inflation variation in advanced
economies and 18 percent in EMDEs. Similarly, the group factor has grown in
importance such that, since 2001, it has accounted for 21 percent in the median
advanced economy and 8 percent in the median EMDE. However, there has
been wide heterogeneity in these shares across countries, especially among
EMDEs, pointing to the importance of country characteristics (Monacelli and
Sala 2009; Neely and Rapach 2011). This section briefly examines the country-
specific correlates of the contribution of the global and group-specific factors to

EMDE inflation variation.
Correlates of the contribution of the global factor. The global factor has
generally contributed more to inflation variation in advanced economies than in
EMDEs and, among EMDE regions, has contributed most in East Asia and
Pacific, Latin America and the Caribbean, and South Asia. The global inflation
factor also explains a larger share of inflation variation in commodity-importing
and more trade-open EMDEs (Figure 2.6). Lower trade openness and the heavy
reliance on commodity exports in three-quarters of LICs may, in part, explain
the weak inflation synchronization in LICs.
A panel regression of the contribution of global or group factors to inflation

variation on indicators of integration into the global economy and policy
frameworks helps identify those features that are most significantly correlated
with greater inflation synchronization. The data set includes annual data for 25
advanced economies and 58 EMDEs (of which 16 are LICs) for 1970-2017.
The results suggest that the global factor was significantly more important for
inflation in countries with higher trade openness, greater commodity-import
intensity, and lower trade concentration (Table A.2.1.4, Annex 2.1). This is
consistent with studies that have attributed inflation synchronization to trade or
supply chain integration in advanced economies (Box 2.1).8
Evolution of the contribution of the global factor over time. The cross-country
heterogeneity in the contribution of the global factor to inflation variation seems
to have been a phenomenon of the 1970s-1990s that largely disappeared in the
2000s. During 1970-85, as in the full sample period, higher trade openness,
commodity importer status, and a more flexible exchange rate regime were each
associated with greater contributions of the global factor to inflation. Since
2001, these differences have become less pronounced: the range of contributions
of the global factor narrowed from 0-87 percent in 1970-85 to 0-58 percent in
2001-17, without any evidence of systematic differences by country
characteristics (Figure 2.6; Table A.2.1.4, Annex 2.1).9
Correlates of the contribution of the EMDE factor. Overall, the contributions

of the EMDE-specific factor to inflation variation were more homogeneous
8 See Monacelli and Sala (2009); Karagedikli, Mumtaz, and Tanaka (2010); Martínez-García (2015);
and Auer, Borio, and Filardo (2017). For instance, in a Phillips curve framework, Auer, Borio, and
Filardo (2017) present evidence that cross-border trade in intermediate goods and services is the main
channel through which global economic slack influences domestic CPI inflation.
9 In the regression analysis, this loss of systematic differences is apparent in the lack of statistically
significant coefficients in the subsample for 2001-17 in Table A.2.1.4, Annex 2.1.
FIGURE 2.6 Contribution of the global factor to inflation: EMDEs

Among EMDEs, the share of the global factor in domestic inflation variance has been
particularly high in East Asia and Pacific, Latin America and the Caribbean, and South
Asia. In trade-open EMDEs and commodity-importing EMDEs, the global factor also
explains a larger share of domestic inflation variance than elsewhere. Since 2001, the
differences across EMDE country groups have narrowed, and the contribution of the global
factor has become more broad-based.
A. EMDE regions, 1970-2017 B. EMDE regions, over time
C. By EMDE country groups, 1970-2017 D. By EMDE country groups, over time
Source: World Bank

Note: Contribution of global and group inflation factors to inflation variance. The global and group inflation factors are
estimated with the baseline two-factor dynamic factor model for 1970-2017 (Annex 2.1). The sample includes 25 advanced
economies and 74 EMDEs, including 16 low-income countries. CMA = commodity importing EMDEs; CXA = commodity
exporting EMDEs; EAP = East Asia and Pacific; EMDEs = emerging market and developing economies; Float = EMDEs
with floating exchange rate regimes; LAC = Latin America and the Caribbean; MNA = Middle East and North Africa;
Peg. = EMDEs with pegged exchange rate regimes; SAR = South Asia; SSA = Sub-Saharan Africa;
Trade closed = EMDEs with lower trade openness, measured by the trade-to-GDP ratio (below the median across
countries); Trade open = EMDEs with higher trade openness measured by the trade-to-GDP ratio (above the median
across countries).
than those for the global factor and have, if anything, also become more
homogeneous over time. That said, there are some systematic differences by
country characteristics. In particular, the group factor contributed more to
inflation variation in commodity exporters as well as in countries with pegged
exchange rates (Figure 2.6; Table A.2.1.5, Annex 2.1). However, these correlates
have shifted over time such that, since 2001, the exchange rate regime has no
longer been systematically correlated with the contribution of the group factor.
Instead, since 2001, as a growing number of EMDEs shifted toward inflation
targeting monetary policy regimes, a systematic negative correlation has emerged

between the contribution of the group factor to inflation variation and inflation
targeting.
Conclusion
This chapter examines three questions about the extent of global inflation
synchronization.
How has inflation synchronization evolved over time? Inflation has become
increasingly synchronized globally: 18 percent (in the median EMDE) to 27
percent (in the median advanced economy) of inflation variation since 2001 has
been accounted for by the global factor. Over the past four decades, an EMDE-
specific factor has emerged that has explained about 8 percent of EMDE
inflation variation since 2001, one-quarter higher than in the 1970s although
still below the contribution of an advanced economy factor (21 percent).
Inflation synchronization varies widely across countries but has become more
broad-based over time. During 1986-2000, the global factor contributed more
than 10 percent to inflation variation in around one-third of the countries in the
sample; by 2001-17, this share had risen to two-thirds.
Which goods and price indexes have been associated with greater inflation
synchronization? Inflation synchronization has become more pronounced across
inflation measures over time. Although the global factor continues to contribute
much more to inflation measures with a higher tradables content (import prices
and the PPI) than to measures with a lower tradables content (core and headline
CPI and the GDP deflator), this contribution has risen for all inflation measures:
to two-thirds for PPI inflation and around one-third for core CPI inflation and
GDP deflator growth.
Which country characteristics have been associated with greater inflation
synchronization? Countries differ widely in the degree to which global factors
and, to a lesser extent, group factors account for domestic inflation variation.
The global factor has accounted for a larger share of domestic inflation variation
in countries that have been more open to global trade, relied on commodity
imports, had more concentrated trade, were more economically developed, or
were EMDEs in the East Asia and Pacific, Latin America and the Caribbean,
and South Asia regions. That said, over the past four to five decades, this
heterogeneity has narrowed such that, since 2001, no country characteristic
appears to account systematically for the greater contributions of global factors.
Since 2001, the EMDE group factor has explained a greater share of inflation
variability in EMDEs that did not have inflation targeting monetary policy
frameworks.
The increased synchronicity of global inflation could pose challenges for policy
makers. Inflation synchronization in and of itself need not warrant policy
intervention (IMF 2018). However, it increases the risk of policy errors when
the appropriate response to excessively low or high inflation differs depending
on the origin (domestic or foreign) of the underlying inflation shock (Hartmann
and McAdam 2018). In the context of exchange rate pass-through, this issue is
explored in detail in Chapter 5.
Inflation synchronization raises concerns that central banks’ control over
domestic inflation may have weakened (Carney 2017). Heads of major advanced
economy central banks have acknowledged the need to consider the global
environment in setting monetary policy (Bernanke 2007; Draghi 2015; Carney
2015). Weaker monetary policy transmission would increase the burden on
fiscal policy to respond to excessive or deficient domestic demand. It would also
increase the need for product and labor market flexibility to be able to adjust
before relative price changes driven by foreign shocks turn into general inflation.
Global inflation synchronization could also strengthen the case for coordinated
policy action (IMF 2018). A coordinated response to uncomfortably low or high
global inflation could amplify the impact of policies advanced by an individual
country.
Future research could take two directions. First, it could delve further into the
sources of the inflation synchronization that has been documented here.
Synchronization could be generated by common shocks that affect all countries,
or by country-specific shocks that spill over between countries. This chapter—
as well as the next one—is agnostic about these two sources. Second, this
chapter estimates synchronization in short-term inflation movements, not in
long-term inflation trends. Yet, as documented in Chapter 1, inflation has
trended downward steeply around the world over the past four decades. Future
research could aim to quantify the extent of synchronization in these long-term
inflation trends.
ANNEX 2.1 Methodology and database

Dynamic factor model
Following Kose, Otrok, and Prasad (2012), this chapter decomposes fluctuations
in inflation into one or more latent factors in the context of a dynamic factor
model. Dynamic factor models are designed to extract a small number of
unobservable common elements from the covariance or comovement between
(observable) macroeconomic time series across countries. Thus, the model allows
for a parsimonious representation of the data in terms of the unobservable
common elements—typically referred to as factors. From a theoretical
standpoint, dynamic factor models are appealing because they can be framed as
reduced-form solutions to a standard dynamic stochastic general equilibrium
(DSGE) model.
This chapter estimates two types of common driving forces in fluctuations in

global inflation.
• Global inflation factor. This is the broad common elements in inflation

fluctuations across countries.
• Group-specific inflation factors. These are common elements in the cyclical

inflation fluctuations in the countries in a particular group. Here, it is
assumed that national inflation rates are explained by a “country group”
factor and advanced economy and EMDE factors.
• Residual (“idiosyncratic”) factors. These capture elements in the

fluctuations of an individual variable in a country that cannot be attributed
to the other factors.
Thus, the inflation equation for each country takes the following form:
πi,t = β i Global ƒtGlobal + β i Group ƒtGroup + i,t
where πi denotes inflation in country i; the global and group factors are
represented by ƒtGlobal and ƒtGroup, respectively; and the coefficients before them
(β), typically referred to as factor loadings, capture the sensitivities of the
macroeconomic series to these factors. The error terms ( i,t) are assumed to be
uncorrelated across countries at all leads and lags. The error terms and factors
follow an autoregressive process. The model is estimated using Bayesian
techniques as described in Kose, Otrok, and Whiteman (2003).
The importance of each factor in explaining inflation is measured by the fraction

of total variance of inflation due to the respective factor. This is computed by
applying the variance operator to each equation in the system. Specifically, for
inflation in country i:
Var (πi) = (β i Global)2 Var ( ƒ Global) + (β i Group)2 Var ( ƒ Group) + Var ( iπ)
Since there are no cross-product terms between the factors, the variance in
inflation attributable to the global factor is:
(β i Global)2 Var ( ƒ Global )

Var (πi)
The variance shares due to the group factors and idiosyncratic terms are
calculated using a similar approach.
Regression analysis between the variance contributions of the

inflation factors and country characteristics
To explore the relations between the impact of global and group-specific
inflation factors on domestic inflation, the contributions of the global and group
factors in individual countries are regressed on a variety of indicators for country
characteristics. They include variables on the structure of an economy as well as
policy frameworks. The variables include dummy variables for above-average
commodity import intensity, income groups, and regions; dummy variables for
exchange rate and monetary policy regimes; measures of trade and financial
openness (trade-to-GDP ratio, capital account openness index by Chinn and Ito
[2017], and index of trade concentration) and degree of participation in global
value chains (share of foreign value added in exports); and measures of central
bank independence and transparency and the turnover ratio of central bank
heads. A more detailed description of the country characteristics is provided in
the Appendix.
The regression analysis starts with a set of bivariate regressions that include a
variable of interest and the constant as explanatory variables for the global or
group factor’s variance share of inflation. Based on the results from bivariate
regressions, a multivariate regression is estimated using Bayesian model averaging
(baseline) or multivariate least squares (for robustness). Considering that
regional dummy variables are highly correlated with other structural and policy
variables, each set of multivariate regressions is executed with and without the
regional dummy variables. The estimations are conducted for the full sample
(1970-2017) as well as three subsamples (1970-85, 1986-2000, and 2001-17).
The list of countries is provided in Table A.2.1.2, Annex 2.1.
TABLE A.2.1.1 Factor models for inflation synchronization in the literature
Empirical
Inflation framework
Related work Data coverage Results
measures (economic
factors)
A simple average of 22 OECD countries’ inflation, which the authors call global inflation,
accounts for almost 70 percent of the variance of inflation in these countries between
1960Q1 and 2008Q2. First, at business cycle frequencies, the variance explained by
22 OECD
Ciccarelli and Headline Static factor model global inflation is about 37 percent on average and much larger in many countries.
countries (1960-
Mojon (2010) CPI (one global factor) Second, domestic inflation reverts to the global component. Third, in countries that have
2008, quarterly) experienced stronger commitment to price stability (such as Germany) global inflation has
a lesser impact on domestic inflation than in those with weaker inflation discipline (such as
Italy).
Principal The first common factor is an important determinant of national inflation rates in industrial
30 OECD and 6
Headline component countries and non-industrial and regional inflation rates (with R squareds of regressions of
non-OECD
Hakkio (2009) and core analysis (global national inflation on the first common factor averaging 0.71). The commonality of industrial
countries (1960-
CPI and regional inflation rates appears to reflect the commonality of macro variables that are determinants
2008, quarterly)
factors) of inflation.
For the median country, the global component accounts for 51percent of the variance of
Dynamic factor the PPI. Input-output linkages account for half of this global component of PPI inflation. On
Auer, 30 countries
Sectoral model (global, average, a shock that raises inflation by 1 percent in the other countries in the world other
Levchenko, and (1995-2011,
PPI sectoral, and than the country under observation raises domestic PPI by 0.19 percent. PPI
Sauré (2017) monthly)
country factors) synchronization across countries is driven primarily by common sectoral shocks and input-
output linkages amplify comovement primarily by propagating sectoral shocks.
Global inflation accounts for a large share of the variance of national inflation rates in
OECD countries. For middle-income countries the share of national inflation variance
explained by global factors is on the order of 15 to 20 percent, falling to around 10 percent
223 countries Dynamic for low-income countries. Higher income, greater financial sector development, and more
Sub-com-
(unbalanced hierarchical model transparent central banks are associated with a larger influence of global inflation.
ponents of
Parker (2018) panel) (global, index- Relatively rich countries with deep domestic capital markets and good monetary policy are
CHAPTER 2
headline
(1980-2010, specific, and group likely to be better able to mitigate idiosyncratic, domestic shocks. Global inflation factors
CPI also have greater influence on the national inflation rates of countries with fixed exchange
quarterly) factors)
rates. There is a more marked influence of global energy and food prices on the
127
respective national inflation rates. Housing prices appear for the most part idiosyncratic
and unrelated to global factors.
TABLE A.2.1.1 Factor models for inflation synchronization in the literature (continued) 128
Empirical
Inflation
Related work Data coverage framework Results
measures
(economic factors)
The historical decline in the level and persistence of inflation is shared by most countries.
An international factor tracks the level and persistence of national inflation rates
CHAPTER 2
reasonably well. The rise and fall of national contributions to inflation fluctuations are not
Headline CPI 10 advanced Dynamic factor synchronized across economies and their timing confirms conventional wisdom on the
Mumtaz and conduct of national policies: income policies and accommodative monetary policies are
other inflation economies (1961- model (global and
Surico (2012) associated with periods of volatile inflation in the United Kingdom, the United States, Italy,
indicators 2004, quarterly) country factors) and Japan. The fall in inflation predictability is a common feature of the industrialized
world since the late 1980s. Differences in the pace of productivity growth appear
important to explain differences in the national factors. International comovements in
money growth are significantly related to international comovements in inflation.
The global factor explains 35 percent of annual inflation variability on average across the
64 countries; the regional factor explains 16 percent of inflation variability on average; and
the country-specific component explains 49 percent. Although the world factor explains
about a third of inflation variability on average across countries, its importance within that
Neely and Dynamic factor group varies substantially (83 percent of inflation variability in Canada; less than 10
Rapach 64 countries (1950-
Headline CPI model( global and percent in some other countries). The global inflation factor more strongly influences
2009, annual)
(2011) regional factors) advanced economies with strong institutions, developed financial markets, low average
inflation, and independent central banks. The relative importance of the factors is fairly
stable over subsamples 1951-79 and 1980-2009, although the regional (global) factor
clearly increases in importance for several North American and European (Latin American
and Asian) countries during the second subsample.
Forster and Headline, food 101 economies Hierarchical factor About two-thirds of overall inflation volatility is due to country-specific determinants. For
Tillmann (2014) and energy CPI (1996:1-2011:4) model CPI inflation net of food and energy, the global factor and CPI basket–specific factor
account for less than 20 percent of inflation variation. Only energy price inflation is
dominated by common factors.
Karagedikli, CPI of 28 product 14 advanced Dynamic factor Category-specific (for 28 product categories) factors account for a large part of the
Mumtaz and categories economies (1998:1 model comovement in the prices of goods in advanced economies which are intensive in
Tanaka (2010) -2008:2) internationally traded primary commodities; but this is less evident for other traded goods.
The world factor and the category-specific factors become more significant in explaining
the movement in the relative prices in the second half of the sample (2003-08).
TABLE A.2.1.1 Factor models for inflation synchronization in the literature (continued)
Empirical
Inflation
Related work Data coverage framework Results
measures
(economic factors)
The share of volatility explained by global inflation remains

dominant. In a (pseudo) out-of-sample exercise, global inflation
Ferroni and Forecasting model remains the only variable that can help to improve the one-year-
Headline CPI 22 OECD countries (1991:1-2013:3)
Mojon (2018) suite ahead inflation forecast relative to univariate models. Commodity
prices do not seem to be better predictors of domestic inflation
dynamics than measures of global inflation.
Fluctuations in nominal variables—aggregate price levels and

nominal interest rates—are documented to be substantially more
Henriksen, synchronized across countries at business cycle frequencies than
Kydland and Headline CPI 6 advanced economies (1974:1-2006:4) Bilateral correlations bilateral correlations fluctuations in real output. Specifically, for
Šustek (2013) 1960:1-2006:4 the average bilateral correlation of price levels is
0.52, that of short-term nominal interest rates 0.57, while that of real
GDP is only 0.25.
The average cross-country correlation of inflation is significantly and

systematically stronger than that of output, and the cross-country

Wang and Wen correlation of money growth is essentially zero. Yet, movements in
Headline CPI 18 advanced economies Correlations
(2006) the money stock are not significantly and systematically correlated
across countries. Neither the new Keynesian sticky-price model nor
the sticky-information model can fully explain the data.
Note: CPI = consumer price index; OECD = Organisation for Economic Co-operation and Development; PPI = producer price index.
CHAPTER 2
129
TABLE A.2.1.2 List of countries 130
A. Full-sample country group (headline CPI inflation)
Australia; Austria; Belgium; Canada; Cyprus; Denmark; Finland; France; Germany; Greece; Iceland; Ireland; Italy; Japan; Korea,
Advanced economies (25)
Rep.; Luxembourg; New Zealand; Norway; Portugal; Singapore; Spain; Sweden; Switzerland; United Kingdom; and United States
CHAPTER 2
Algeria; Antigua and Barbuda; The Bahamas; Bahrain; Bangladesh; Barbados; Belize; Bhutan; Botswana; Cabo Verde;
Cameroon; China; Colombia; Congo, Rep.; Côte d'Ivoire; Dominica; Dominican Republic; Ecuador; Egypt, Arab Rep.; El Salvador;
Equatorial Guinea; Fiji; Gabon; Grenada; Guatemala; Honduras; Hungary; India; Indonesia; Iran, Islamic Rep.; Jordan; Kenya;
EMDEs (58)
Kuwait; Lesotho; Libya; Malaysia; Maldives; Mauritius; Morocco; Oman; Pakistan; Panama; Papua New Guinea; Paraguay;
Philippines; Samoa; Saudi Arabia; Seychelles; South Africa; Sri Lanka; St. Kitts and Nevis; St. Lucia; St. Vincent and the
Grenadines; Eswatini; Thailand; Trinidad and Tobago; Tunisia ;and Vanuatu
Benin; Burkina Faso; Burundi; Central African Republic; Comoros; Ethiopia; The Gambia; Guinea; Madagascar; Mali; Nepal; Niger;
LICs (16)
Rwanda; Senegal; Tanzania; and Togo
B. Subsample country group (five inflation measures)
Australia; Austria; Belgium; Canada; Cyprus; Denmark; Finland; France; Germany; Greece; Ireland; Italy; Japan; Korea, Rep.;
Advanced economies (25) Luxembourg; Netherlands; New Zealand; Norway; Portugal; Singapore; Spain; Sweden; Switzerland; United Kingdom; and United
States
Egypt, Arab Rep.; El Salvador; Hungary; India; Indonesia; Iran, Islamic Rep.; Kuwait; Pakistan; Panama; Philippines; South Africa;
EMDEs (13)
Thailand; and Tunisia
Note: Numbers in the parentheses indicate the number of countries in each group. EMDEs exclude LICs. CPI = consumer price index; EMDEs = emerging market and developing economies;
LICs = low-income countries.
TABLE A.2.1.3 Variance decompositions over time: Various inflation measures—Panel A. Import Prices (Percent)
1970-85 1986-2000 2001-16
67.7 8.7 50.1
Global
(62.6, 54.9 - 74.9) (15.5, 3.1 - 24.5) (49.2, 42.6 - 63.3)
5.1 18.5 11.4
Group
(10.7, 0.7 - 13.9) (25.7, 2.8 - 44.5) (13.7, 6.1 - 19.2)
77.5 37.6 67.7
Global + Group
(73.2, 64.3 - 85.5) (41.2, 18.5 - 58.8) (62.9, 48.6 - 77.6)
66.3 8.7 59.2
Global
(62.3, 54.9 - 74.9) (14.9, 3.4 - 24.5) (50.9, 44.3 - 63.3)
5.1 18.5 11.4
Group
(8.7, 0.7 - 10.5) (28.6, 3.9 - 52.3) (13.6, 6.1 - 18.4)
71.7 39.1 68.0
Global + Group
(71.1, 61.8 - 85.5) (43.5, 18.5 - 69.2) (64.4, 52.0 - 77.6)
Factor EMDEs
70.1 9.9 42.2
Global
(63.5, 56.8 - 76.8) (18.2, 2.9 - 25.1) (42.4, 36.9 - 47.8)
8.2 11.8 12.9
Group
(18.9, 1.8 - 25.2) (13.2, 2.5 - 22.5) (13.9, 5.0 - 21.8)
82.5 33.9 49.4
Global + Group
(82.4, 79.9 - 85.0) (31.4, 23.8 - 41.4) (56.4, 47.0 - 58.7)
Note: The contribution of global and group inflation factors to inflation variance is estimated over the three subsample periods with a two-factor dynamic factor model for each of the five different inflation
CHAPTER 2
measures: import prices, PPI, headline, GDP deflator, and core CPI. The data set includes 38 countries (25 advanced economies and 13 EMDEs) except import prices for 21 countries (17 advanced
economies and 4 EMDEs). The first argument in the first row indicates the unweighted median across countries. The first argument in the second row (in parentheses) is the mean variance share across
countries. The second and third arguments in the second row (in parentheses) indicates the interquartile range (25th and 75th percentiles) of variance shares. CPI = consumer price index; EMDEs =
131
emerging market and developing economies; GDP = gross domestic product; PPI = producer price index.
TABLE A.2.1.3 Variance decompositions over time: Various inflation measures—Panel B. PPI (Percent) 132
1970-2016 1970-85 1986-2000 2001-16

42.1 52.3 5.2 67.2
Global
(41.1, 15.3 - 61.7) (45.2, 22.1 - 67.5) (9.2, 2.3 - 11.2) (61.4, 55.1 - 76.4)
CHAPTER 2
6.6 7.3 16.7 3.9

Group
(3.2, 0.9 - 8.8) (12.6 , 2.2 - 18.3) (22.5, 7.1 - 29.9) (6.1, 1.3 - 8.1)
49.9 65.0 24.9 71.3
Global + Group
(45.2, 19.7 - 67.3) (54.8, 32.9 - 81.0) (30.0, 16.1 - 42.7) (63.9, 54.9 - 82.1)
56.1 62.1 4.0 71.7
Global
(48.4, 33.9 - 63.7) (50.0, 27.5 - 70.7) (9.0, 2.3 - 8.3) (68.3, 65.8 - 77.0)
4.5 7.1 20.7 5.9
Group
(7.7, 1.1 - 9.6) (13.2, 3.2 - 23.1) (28.6, 11.9 - 45.8) (6.8, 1.1 - 8.4)
60.6 71.7 35.8 77.3
Global + Group
(51.6, 31.2 - 68.1) (58.1, 38.9 - 85.1) (34.5, 19.1 - 52.1) (69.1, 66.8 - 87.8)
Factor EMDEs
16.2 33.7 6.9 49.4
Global
(28.3, 11.1 - 40.4) (36.9, 12.9 - 57.8) (9.8, 3.1 - 11.6) (49.0, 27.6 - 63.4)
1.4 11.4 13.2 3.5
Group
(4.7, 0.8 - 4.0) (11.6, 2.2 - 16.6) (11.7, 5.2 - 15.9) (4.8, 2.4 - 7.4)
22.6 50.3 20.0 57.6
Global + Group
(33.0, 13.5 - 41.0) (48.4, 31.5 - 70.0) (21.4, 14.9 - 26.6) (53.9, 41.2 - 66.6)
Note: The contribution of global and group inflation factors is estimated over the three subsample periods with the dynamic factor model (two-factor model) for each of the five different inflation measures:
import prices, PPI, headline, GDP deflator, and core CPI. The data set includes 38 countries (25 advanced economies and 13 EMDEs) except import prices for 21 countries (17 advanced economies and
4 EMDEs). The first argument in the first row indicates the unweighted median across countries. The first argument in the second row (in parentheses) is the mean variance share across countries. The
second and third arguments in the second row (in parentheses) indicate the interquartile range (25th and 75th percentiles) of variance shares. CPI = consumer price index; EMDEs = emerging market and
TABLE A.2.1.3 Variance decompositions over time: Various inflation measures—Panel C. Headline CPI (Percent)
1970-2016 1970-85 1986-2000 2001-16
15.7 18.7 4.0 32.8
Global
(22.9, 6.2 - 36.5) (28.2, 10.3 - 42.4) (5.8, 1.9 - 7.5) (30.8, 19.5 - 44.7)
9.1 8.6 5.7 19.1
Group
(12.8, 3.4 - 21.4) (14.5, 3.8- 22.9) (9.5, 4.8 - 10.3) (20.2, 10.3 - 24.7)
34.1 42.9 12.1 55.2
Global + Group
(35.7, 25.4 - 44.6) (42.7, 25.0 - 56.7) (15.3, 8.1 - 19.0) (51.2, 47.7 - 60.8)
21.4 20.0 4.3 37.0
Global
(23.7, 11.0 - 36.6) (27.3, 8.7 - 42.6) (6.2, 1.9 - 7.6) (35.0, 28.8 - 44.9)
11.5 19.8 5.5 17.3
Group
(14.0, 4.1 - 24.1) (18.9, 4.3 - 29.7) (6.4, 4.7 - 7.0) (16.6, 9.1 - 19.9)
35.9 45.1 12.0 54.4
Global + Group
(37.7, 31.1 - 44.8) (46.1, 28.3 - 59.1) (12.6, 7.8 - 14.6) (52.8, 48.5 - 58.3)
Factor EMDEs
11.6 17.4 3.2 18.1
Global
(21.4, 3.4 - 36.3) (30.0, 13.8 - 41.9) (5.1, 1.0 - 5.2) (21.0, 3.4 - 24.7)
7.7 6.8 10.2 25.6
Group
(10.4, 0.9 - 11.8) (6.2, 3.2 - 8.6) (15.5, 5.7 - 19.2) (30.4, 12.4 - 42.6)
25.6 26.2 12.6 59.2
Global + Group
(31.9, 16.7 -43.9) (36.2, 23.0 - 45.1) (20.6, 10.1 - 27.8) (48.3, 28.8 - 64.7)
CHAPTER 2
second and third arguments in the second row (in parentheses) indicate the interquartile range (25th and 75th percentiles) of variance shares. The results differ from Tables 2.1 and 2.2 because of the
133
smaller sample size to match the sample with available data for other measures of inflation. CPI = consumer price index; EMDEs = emerging market and developing economies; GDP = gross domestic
product; PPI = producer price index.
TABLE A.2.1.3 Variance decompositions over time: Various inflation measures —Panel D. GDP deflator (Percent) 134
1970-2016 1970-85 1986-2000 2001-16

12.6 13.7 7.4 33.4
Global
(18.7, 3.2 - 30.5) (25.9, 5.5 - 43.0) (16.7, 3.1 - 28.8) (32.4, 16.2 - 50.0)
CHAPTER 2
12.1 12.7 7.1 4.1

Group
(16.0, 4.6 - 25.5) (18.6, 5.8 - 28.3) (11.7, 3.4 - 18.8) (11.3, 0.8 - 10.9)
35.3 45.3 25.0 44.8
Global + Group
(33.8, 19.1 - 45.0) (43.3, 19.9 - 63.2) (27.6, 11.8 - 37.8) (42.6, 30.7 - 58.0)
13.4 14.8 12.8 35.7
Global
(19.1, 6.5 - 31.5) (27.1, 9.4 - 42.1) (18.1, 3.4 - 28.9) (34.4, 19.5 - 48.0)
12.6 9.3 7.2 2.3
Group
(15.9, 3.5 - 25.0) (13.8, 5.0 - 23.0) (11.5, 3.4 - 15.9) (3.2, 0.6 - 5.2)
33.6 37.8 29.7 39.2
Global + Group
(37.3, 18.1 - 45.8) (39.3, 19.9 - 59.3) (28.4, 15.9 - 42.8) (36.1, 22.1 - 47.6)
Factor EMDEs
9.3 9.8 3.5 19.7
Global
(18.0, 2.2 - 26.1) (23.7, 1.9 - 44.5) (14.2, 3.1 - 15.5) (28.7, 10.3 - 50.0)
9.5 19.6 7.1 25.5
Group
(16.2, 6.2 - 25.5) (27.5, 9.1 - 44.5) (12.0, 3.4 - 18.8) (26.3, 10.4 - 44.4)
33.7 54.9 22.8 56.7
Global + Group
(34.2, 22.2 - 37.4) (51.2, 32.5 - 70.1) (26.2, 10.5 - 35.9) (55.0, 53.0 - 65.5)
second and third arguments in the second row (in parentheses) indicate the interquartile range (25th and 75th percentiles) of variance shares. CPI = consumer price index; EMDEs = emerging market and
TABLE A.2.1.3 Variance decompositions over time: Various inflation measures —Panel E. Core CPI (Percent)
1970-2016 1970-85 1986-2000 2001-16
4.7 8.4 5.4 29.8
Global
(12.5, 1.7 - 15.4) (14.2, 6.9 - 14.5) (17.5,1.3 - 29.1) (27.8, 9.7 - 42.1)
14.1 16.5 10.6 3.5
Group
(18.8, 2.9 - 26.6) (18.9, 5.2 - 31.8) (15.3, 3.1 - 25.6) (5.8, 2.1 - 7.7)
26.5 28.6 31.3 33.0
Global + Group
(27.9, 10.9 - 40.4) (29.6, 11.6 - 44.3) (29.2, 11.9 - 44.9) (30.0, 13.8 - 46.9)
7.9 8.5 5.3 31.9
Global
(14.5, 3.1 - 21.4) (16.0, 7.7 - 22.6) (16.1, 2.3 - 26.3) (29.5, 25.0 - 44.1)
17.7 16.9 17.9 3.1
Group
(21.9, 8.7 - 34.8) (21.0, 5.2 - 35.7) (17.1, 2.3 - 29.2) (5.8, 2.0 - 5.4)
34.6 40.1 31.8 35.1
Global + Group
(34.9, 18.9 - 46.4) (35.5, 13.2 - 53.7) (30.9, 20.6 - 46.6) (33.0, 20.6 - 47.7)
Factor EMDEs
1.7 10.1 26.3 22.2
Global
(8.0, 1.3 - 9.1) (8.9, 2.5 - 12.9) (26.2, 0.7 - 29.1) (23.3, 0.6 - 29.0)
2.9 9.4 7.0 6.4
Group
(11.5, 1.5 - 13.5) (11.5, 5.3 - 19.2) (6.9, 4.6 - 10.9) (7.6, 4.2 - 13.2)
11.8 17.2 22.4 11.8
Global + Group
(15.0, 3.0 - 16.5) (18.7, 5.6 - 27.5) (24.9, 5.9 - 33.6) (22.9, 1.1 - 31.1)
CHAPTER 2
second and third arguments in the second row (in parentheses) indicate the interquartile range (25th and 75th percentiles) of variance shares. CPI = consumer price index;
EMDEs = emerging market and developing economies; GDP = gross domestic product; PPI = producer price index.
135
TABLE A.2.1.4 Correlates of the variance share of the global inflation

factor
All 1970-85 1986-2000 2001-17
0.03 0.033 0.01 -0.02
EMDE
(0.07) (0.09) (0.04) (0.06)
0.00 0.00 0.00 0.00
GDP per capita
(0.00) (0.00) (0.00) (0.00)
-0.11** -0.059 0.04 -0.02
Commodity exporter
(0.04) (0.06) (0.04) (0.04)
-0.06 -0.09 0.07 -0.03
Inflation target
(0.05) (0.07) (0.04) (0.05)
0.004 0.003 0.002 0.001
Exchange rate peg (R)
(0.02) (0.03) (0.02) (0.02)
-0.05 -0.11** -0.02 0.03
Exchange rate peg (S)
(0.04) (0.05) (0.03) (0.03)
0.001** 0.001 0.00 0.00
Trade openness
(0.00) (0.00) (0.00) (0.00)
-0.33** -0.58*** -0.004 -0.047
Trade concentration
(0.12) (0.17) (0.1) (0.10)
0.06 0.13 0.02 0.088
Financial openness
(0.07) (0.09) (0.06) (0.06)
-0.003 -0.004 -0.001 -0.001
Global value chain
(0.00) (0.00) (0.00) (0.00)
-0.001 -0.001 0.002** 0.00
Debt-to-GDP ratio
(0.00) (0.00) (0.00) (0.00)
Central bank independence and -0.004 -0.027* -0.01 -0.003
transparency (0.01) (0.01) (0.01) (0.01)
Note: Results of an ordinary least squares regression of the variance share of the global factor in inflation variation on a
number of country characteristics as explanatory variables. The global factor is estimated with the dynamic factor model
described in this Annex for the period of a full sample (1970-2017) and three subsamples (1970-85, 1986-2000, and
2001-17). The global factor is estimated in a sample of 99 countries (25 advanced economies and 74 EMDEs, including 16
low-income countries). Of these, 25 advanced economies and 58 EMDEs are included in this regression. The numbers in
parentheses refer to standard errors (*** p < 0.01, ** p < 0.05, *p < 0.1). Inflation targeting regimes are defined as in IMF
(2016). A value of 1 indicates the existence of an inflation targeting regime, a value of 0 its absence. Exchange rate regime
(R) is based on Ilzetzki, Reinhart, and Rogoff (2017), and exchange rate regime (S) is based on Shambaugh (2004). A
higher value indicates greater exchange rate flexibility. The measures of trade and capital account openness are,
respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled by Chinn and Ito (2006). Trade
concentration is based on product concentration and diversification indexes of exports and imports by UNCTAD. Central
bank independence and transparency is based on Dincer and Eichengreen (2014). A higher value indicates greater central
bank independence and transparency. The EMDE dummy equals 1 for any EMDE and 0 for any other country. Dependent
variables are based on median values over the country-specific sample periods except that the variables on exchange rate
regime and inflation targeting are based on the mode. For details on the data definitions, refer to the Appendix.
TABLE A.2.1.5 Correlates of the variance share of the group inflation

factor
All 1970-85 1986-2000 2001-17
-0.13* 0.00 -0.17 -0.20**
EMDE
(0.07) (0.02) (0.11) (0.10)
0.00 -0.02 0.04 -0.25**
LIC
(0.06) (0.04) (0.1) (0.13)
0.00 0.00 0.00 0.00
GDP per capita
(0.00) (0.00) (0.00) (0.00)
0.09** -0.02 0.08 0.04
Commodity exporter
(0.04) (0.03) (0.06) (0.03)
-0.07 0.005 -0.12 -0.07*
Inflation target
(0.05) (0.05) (0.08) (0.04)
0.13*** 0.06** 0.20*** 0.02
Exchange rate regime (S)
(0.04) (0.03) (0.05) (0.03)
0.00 0.00 0.00 0.00
Trade openness
(0.00) (0.00) (0.00) (0.00)
0.10 0.11 0.20 -0.17*
Trade concentration
(0.11) (0.10) (0.16) (0.09)
-0.10 0.04 -0.19** 0.03
Financial openness
(0.06) (0.05) (0.09) (0.05)
0.00 0.00 0.00 0.00
Global value chain
(0.00) (0.00) (0.00) (0.00)
0.00 0.00 0.00 0.00
Debt-to-GDP ratio
(0.00) (0.00) (0.00) (0.00)
Central bank independence and 0.01 0.02** 0.03** -0.01
transparency (0.01) (0.01) (0.01) (0.01)
Note: Results of an ordinary least squares regression of the variance share of the EMDE factor in inflation variation on a
number of country characteristics as explanatory variables. The global factor is estimated with the dynamic factor model
described in this Annex for the period of a full sample (1970-2017) and three subsamples (1970-85, 1986-2000, and
2001-17). The global factor is estimated in a sample of 99 countries (25 advanced economies and 74 EMDEs, including 16
LICs). Of these, 25 advanced economies and 58 EMDEs are included in this regression. The numbers in parentheses refer
to standard errors (*** p < 0.01, ** p < 0.05, *p < 0.1). Inflation targeting regimes are defined as in IMF (2016). A value of 1
indicates the existence of an inflation targeting regime, a value of 0 its absence. Exchange rate regime (S) is based on
Shambaugh (2004). A higher value indicates greater exchange rate flexibility. The measures of trade and capital account
openness are, respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled by Chinn and Ito
(2006). Trade concentration is based on product concentration and diversification indexes of exports and imports by
UNCTAD. Central bank independence and transparency is based on Dincer and Eichengreen (2014). A higher value
indicates greater central bank independence and transparency. The LIC dummy equals 1 for any LIC and 0 for any other
country. The EMDE dummy equals 1 for any EMDE and 0 for any other country. Dependent variables are based on median
values over the country-specific sample periods except that the variables on exchange rate regime and inflation targeting
are based on the mode. For details on the data definitions, refer to the Appendix. EMDEs = emerging market and
developing economies; GDP = gross domestic product; LIC = low-income country.
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CHAPTER 3
Sources of Inflation: Global and Domestic Drivers
This chapter examines the key drivers of fluctuations in global and domestic
inflation. It finds, first, that global demand shocks and oil price shocks have been the
main drivers of variations in global inflation. Global demand shocks have become
increasingly more important in explaining global inflation movements since 2001.
Second, domestic shocks have explained the lion’s share of domestic inflation
variation. Domestic supply shocks have accounted for a larger share of inflation
variance than other domestic shocks, but their importance has declined since the
1970s and 1980s. Global shocks have been responsible for around one-quarter of the
variation in domestic inflation. Third, global shocks have contributed more to
domestic inflation variation in advanced economies than in emerging market and
developing economies. They have been a more important source of domestic inflation
movements in countries with stronger global trade and financial linkages, greater
dependence on commodity imports, and fixed exchange rate regimes.
Introduction
Since 1970, global inflation—defined here as the median of national inflation
rates—has undergone considerable swings around a pronounced downward
trend. These swings in inflation have often been associated with cyclical
fluctuations in the global economy or sharp movements in oil prices (Figure
3.1). Between the early 1970s and the mid-1990s, inflation rose in many
emerging market and developing economies (EMDEs) amid jumps in oil prices,
currency crises, and price liberalization programs that followed economic
collapse (especially in the countries of the former Soviet Union) (Chapter 1).
Conversely, short-lived oil price plunges in the mid-1980s and early 1990s were
accompanied by declines in inflation in advanced economies and EMDEs.
The period since the global financial crisis has been marked by an unusually
pronounced and broad-based disinflation around the world. About 80 percent
of countries worldwide experienced disinflation in 2008-09 and 75 percent of
EMDEs experienced another bout of disinflation in the 2010s—the highest
proportions since the 1980s. Roughly 80 percent of advanced economies and 40
percent of EMDEs experienced outright deflation—also exceptionally high
proportions (Figure 3.2).
Note: This chapter was prepared by Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge, and Hakan
Yilmazkuday. Annex 3.1 was prepared by Wee Chian Koh. Background materials for the literature review
were provided by Atsushi Kawamoto.
FIGURE 3.1 Global and domestic inflation

Since 1970, global inflation has undergone considerable swings around a pronounced
downward trend. These swings often coincided with global recessions or slowdowns and
recoveries or large oil price fluctuations.
A. Global inflation B. Domestic inflation
Source: OECD; Haver Analytics; World Bank.

A. Global inflation is defined as median quarter-on-quarter annualized inflation among 168 economies. Shaded areas
indicate global recessions and slowdowns (Annex 3.2)
B. Median and interquartile range of quarter-on-quarter annualized inflation among 168 economies.
A growing body of research has examined the roles played by a wide range of
global and domestic shocks in driving fluctuations in domestic inflation. The
theoretical literature has extended the closed-economy macroeconomic models
to open-economy settings that establish links between global shocks and
movements in domestic inflation.1 Empirical studies have estimated the roles
played by different types of global and domestic disturbances in explaining
domestic inflation variation. The results from studies using Phillips curve
models have been mixed, whereas studies using vector autoregression (VAR)–
based methodologies have generally identified sizable contributions of global
shocks to domestic inflation. Studies for the Euro Area have found a particularly
important role for the commodity price plunge of 2014-16 (Annex 3.1). This
research program has typically focused on one shock or transmission channel
without quantifying its importance relative to other shocks. Moreover, although
the literature has established the importance of a global factor in driving
domestic inflation, it has not provided a detailed analysis of the underlying
drivers of global and domestic inflation. Although global demand, supply, and
oil price shocks have all been mentioned as important drivers of global inflation,
their quantitative importance has not been examined in a unified setup.
Against this background, this chapter studies the main drivers of movements in
global and domestic inflation. The chapter addresses the following questions:
1 For theoretical studies, see Kabukçuoğlu and Martínez-García (2018), Gali and Monacelli (2008),
and Martínez-García and Wynne (2010). For empirical work, see Rogoff (2003), Borio and Filardo
(2007), Bianchi and Civelli (2015), Altansukh et al. (2017), and Eickmeier and Kühnlenz (2016).
FIGURE 3.2 Countries with disinflation and deflation

Inflation has been on a pronounced and broad-based downward trend since the mid-
1970s. The share of countries with slowing inflation has closely tracked global economic
downturns and oil price plunges. Advanced economies are more likely than EMDEs to face
disinflation during downturns. Exceptionally high proportions of advanced economies
(more than three-quarters) and EMDEs (more than half) were in outright deflation at some
point during 2010-17.
A. Share of countries with disinflation B. Share of countries with disinflation

episodes episodes: Advanced economies and EMDEs
C. Share of countries with deflation D. Share of countries with deflation:

Advanced economies and EMDEs
Source: World Bank.

Note: Deflation is defined as negative inflation; disinflation is defined as declining (but still positive) inflation.
A.B. Figures are based on 841 disinflation episodes, defined as in Annex 3.2, in 168 countries (of which 134 are EMDEs)
between 1970:1 and 2017:3.
C.D. Deflation is defined as negative quarter-on-quarter inflation rates. Figures are based on data for 168 countries.
• What have been the main drivers of global inflation?
• What have been the main drivers of domestic inflation?
• How have the main drivers of domestic inflation differed by country

characteristics?
This is the first study in the literature to present a comprehensive examination of

the roles of the main drivers of global and domestic inflation for a large panel of
countries over several decades. The chapter makes the following contributions to
the literature:
Rich model, rich set of shocks. The chapter is the first study to examine, in a
single, consistent framework, global and domestic inflation and global and
domestic sources of variation in domestic inflation. It estimates a series of factor-
augmented vector autoregression (FAVAR) models to quantify the roles of
global demand, global supply, oil prices, and a wide range of domestic shocks in
driving global and domestic inflation. Domestic shocks include domestic
demand, domestic supply, monetary policy, and exchange rate shocks.
Global sample and long series. The chapter is the first to employ data for a large
and globally diverse sample of countries (55 countries, including 26 EMDEs)
that allows an analysis of inflation dynamics in advanced economies and EMDEs
over a long period (1970-2017).
• Historical context. The chapter employs event studies to analyze the

movements in global and domestic inflation during major economic events
since 1970. By putting the post-crisis disinflation into historical context, the
chapter highlights its exceptional severity.
• Country characteristics. In addition, the chapter considers a wide range of

country characteristics that are associated with the differing contributions of
global and domestic shocks to domestic inflation variability.
The chapter’s principal conclusions are as follows:
• The past decade witnessed a pronounced and broad-based disinflation that

depressed global inflation well below its (downward) trend. Exceptionally
large fractions of advanced economies (more than three-quarters) and
EMDEs (more than one-half) were in outright deflation at some point
during 2010-17. Rapid decelerations or accelerations in global inflation
have tended to coincide with turning points in the global business cycle or
sharp movements in global oil prices.
• Global demand and oil price shocks have each accounted for 40 percent of
the variation in global inflation since 1970. The relative importance of
global demand shocks has increased since the Great Moderation (1986-
2000), to account for 60 percent of global inflation variation during 2001-
17. The 2014-16 oil price plunge, however, was a major source of post-crisis
global disinflation.
• On average during the past four to five decades, domestic shocks accounted
for about three-quarters of domestic inflation variation. The most important
domestic shocks were supply shocks. They accounted for more of domestic
inflation variation than any other domestic shocks and about as much as all
global shocks combined. Since 2001, however, the role of domestic supply
shocks has declined. Global demand and oil price shocks were the main
source of global shocks’ contributions to domestic inflation variation. During
1970-2017, they accounted for about 14 and 8 percent, respectively, of
domestic inflation variation whereas global supply shocks played a minor
role. Since 2001, however, in part as a result of the global financial crisis
and the 2014-16 oil price plunge, the contributions of global demand and
oil price shocks have increased to 22 and 17 percent, respectively, of
domestic inflation variation.
• The contribution of global shocks to domestic inflation variation was larger

in advanced economies and countries with higher trade and financial
openness, fixed exchange rate regimes, and greater reliance on commodity
imports. In EMDEs, the median contribution of global shocks to domestic
inflation variance in countries with fixed exchange rate regimes and greater
trade and financial openness was more than twice that in other EMDEs.
The next section examines the behavior of inflation during major events of the
past four to five decades and puts the current episode of broad-based disinflation
in historical context. The following section examines the main drivers of global
inflation, in particular, global demand, global supply, and oil price shocks. The
subsequent two sections estimate the roles of global and domestic shocks in
driving movements in domestic inflation. The final section concludes with a
discussion of policy implications and directions for future research.
Evolution of global and domestic inflation

It is important to distinguish at the outset between disinflation and deflation.
Disinflation refers to a period of slowing, but still positive, inflation.2 Deflation
refers to a decrease in the overall price level, or a negative inflation rate.
Over the past half-century, global inflation has experienced significant

movements. Some of these were disinflation episodes that were generally
associated with global recessions, economic slowdowns, or large declines in
global oil prices. For the purposes of this historical exploration, global inflation
is defined as the median of the national trend inflation rates of 25 advanced
economies and 40 EMDEs during 1970-2017.3
2 Federal Reserve Bank of San Francisco (1999); Rogoff (2003); Goodfriend and King (2005);
Coibion and Gorodnichenko (2015); Cogley, Matthes, and Sbordone (2015).

3 In the event study, global inflation is defined as median inflation among 65 countries. The trend is
defined as the nine-quarter centered moving average, as in Ball (1994). For the econometric model
below, global inflation is estimated using a dynamic factor model. The estimation of a global factor
model requires a balanced sample, which restricts the sample size.
Identification of global events. Turning points of global business cycles are

identified using global per capita gross domestic product (GDP) and the
algorithm in Harding and Pagan (2002). The method identifies four troughs of
global business cycles or global recessions in 1975, 1982, 1991, and 2009
(Annex 3.2). These recessions were associated with a wide range of adverse
developments, including financial crises in advanced economies or EMDEs
(Kose and Terrones 2015). Global slowdowns, not involving declines in per
capita GDP, took place during the Asian financial crisis in 1998 and the U.S.
contraction in 2001. In contrast, peaks of global business cycles or global
expansions are observed in 1973, 1981, 1990, and 2008.
Since the 1970s, there have been six oil price plunges. In 1986, 1990-91, 1997-
98, 2001, 2008, and 2014-16, oil prices dropped by more than 30 percent over
a seven-month period (Baffes et al. 2015). Conversely, there have been 14 oil
price spikes (of which nine were reversed within two quarters), periods in which
oil prices jumped by more than 30 percent over a seven-month period. Many of
these episodes were associated with conflict (for example, the first Gulf War in
the early 1990s or the Libyan conflict in the mid-2000s) or geopolitical tensions
(for example, the Iranian Revolution in the 1970s).
Global disinflation during global recessions. Global inflation has fallen
following sharp declines in global output, with a lag of one to three years.
During global recessions, median global trend inflation declined 3 percentage
points, on average, between the year before the trough of the global recession
and the year after. The most recent global recession, in 2009, was followed by a
pronounced drop in inflation (2.3 percentage points on a median basis, from 4.7
percent initial inflation). The disinflation was more than twice as steep among
EMDEs as among advanced economies, but from a higher starting rate. Despite
a quick rebound in both groups after 2009, inflation remained low throughout
the 2010s—around 5 percent in EMDEs and 2 percent in advanced economies
(Figure 3.3).
Global inflation around global expansions. With few exceptions, global trend
inflation increased in the run-up to peaks of global expansions, with a slowdown
after the business cycle turned (Figure 3.4). In the two years preceding the
business cycle peak, median trend inflation rose by about 2.2 percentage points,
on average, over all cyclical peaks since 1970. In the run-up to the most recent
global business cycle peak in 2008:2, EMDE inflation rose considerably faster
(by about 2 percentage points) than advanced economy inflation (0.2 percentage
point) in the two years before the peak. These inflation accelerations were
followed by steep subsequent declines during global recessions or slowdowns.
Global disinflation during oil price plunges. Two of the six oil price plunges
since 1970—1985-86 and 2014-16—largely reflected supply decisions by the
FIGURE 3.3 Global inflation around global recessions and oil price
plunges
Global recessions and oil price plunges were typically associated with slowing global
inflation.
A. Global inflation around global recessions B. Advanced economy and EMDE inflation
around the 2009 global recession
C. Global inflation around oil price plunges D. Advanced economy and EMDE inflation
around the 2014-16 oil price plunge
Source: World Bank; Baffes et al. 2015.

Note: Horizontal axes indicate years before and after the troughs of global recessions or local troughs of the short-term oil
price cycle, as defined in Annex 3.2 (shaded area, t = 0). Global inflation is defined as median trend inflation (nine-quarter
moving average) across 65 countries (balanced samples), consisting of 25 advanced economies and 40 EMDEs.
A.B. Troughs of global recessions are identified using global per capita GDP and the algorithm in Harding and Pagan
(2002) and are consistent with the results in Kose and Terrones (2015).
C.D. There were six oil price plunges of more than 30 percent (1986, 1990-91, 1997-98, 2001, 2008, and 2014-16) (Baffes
et al. 2015). Panel C shows the four episodes with the largest oil price plunges.
Organization of the Petroleum Exporting Countries (OPEC). The organization

raised output limits when faced with growing oil supply from non-OPEC
producers in Mexico and the North Sea in the 1980s and the U.S. shale oil
industry in the 2000s. The other four episodes predominantly reflected weak
demand amid global recessions or slowdowns (World Bank 2015). On average
during all six episodes, median global inflation slowed by around 1 percentage
point between the year before the trough of oil prices and the year after. The
2014-16 oil price plunge was followed by a modest fall in global trend inflation,
which was already low. In the two years to the trough of the most recent oil
price plunge of 2014-16, the decline in EMDE inflation was broadly on par
with that in advanced economy inflation.
FIGURE 3.4 Global inflation around global business cycle peaks

and oil price spikes
Peaks of global expansions and oil price spikes were typically associated with rising global
inflation.
A. Global inflation around global expansions B. Global inflation around oil price spikes
Source: World Bank; Baffes et al. 2015.

Note: Horizontal axes indicate years before and after peaks of global expansions or peaks of the short-term oil price cycle,
as defined in Annex 3.2 (shaded area, t = 0). Global inflation is defined as median trend inflation across 65 countries,
including 25 advanced economies and 40 EMDEs. EMDEs = emerging market and developing economies; GDP = gross
domestic product.
A. Peaks of global expansions are identified using global per capita GDP and the algorithm in Harding and Pagan (2002).
B. There were five oil price spikes of more than 30 percent over a seven-month period that were not reversed within two
quarters (1973-74, 1979, 1987-91, 1999-2002, 2004-08).
Global inflation around oil price spikes. Following oil price spikes, global trend
inflation rose, on average across the spikes, by 2.4 percentage points within a
year. The impact of the supply-driven oil price spikes in the 1970s and 1980s
was much more pronounced (3.5 percentage points, on average, within a year)
than the impact of the largely demand-driven oil price increases of the 1990s
and 2000s (1.1 percentage points, on average, within a year). The steady rise in
oil prices during 2004:3-2008:2 (when oil prices tripled) was associated with
only a modest increase in trend inflation (about 1.4 percentage points), which
mostly reflected sharply rising inflation in EMDEs.
Drivers of global inflation

The event study discussion above suggests that global inflation has exhibited
significant movements over the global business cycle and oil price swings. Global
business cycles are driven by shocks related to global supply and demand, and oil
price shocks. This section quantifies the contributions of these shocks to global
inflation variation.
Methodology
Model and data. A FAVAR model is estimated with three global variables—
global inflation, global output growth, and global oil price growth—all expressed
in quarter-on-quarter growth rates over 1970-2017, in seasonally adjusted
annualized terms, with two lags (Annex 3.3).
Global inflation is defined as the common factor for detrended headline

consumer price index (CPI) inflation estimated using a dynamic factor model.
In parallel, the global output factor is defined as the common factor for real
GDP growth estimated in a separate dynamic factor model (Figure 3.5).
The database for quarterly inflation and output includes the largest country
sample possible over the period 1970- 2017.4 Global oil price growth is proxied
by quarter-on-quarter growth rates of the nominal price of oil in U.S. dollar
terms (average of Dubai, West Texas Intermediate, and Brent prices), as in
Baffes et al. (2015).
Evolution of the global inflation and output factors. The global inflation factor
was highly volatile until the 1990s (Figure 3.5). It stabilized at low levels in the
1990s and early 2000s before declining further during the global financial crisis
and remaining low throughout the post-crisis period. In line with the event
study above, the global inflation factor typically declined during global
recessions and slowdowns. It fell sharply during the global financial crisis and
after the 1975 and 1991 global recessions. Similarly, the global output factor
registered significant declines during global recessions and slowed during global
slowdowns. Oil price spikes during the 1970s and early 1980s, as well as before
the global financial crisis, coincided with rising global inflation.
Identification of shocks. Global demand shocks, global supply shocks, and oil-
price shocks are identified using a set of sign restrictions on interactions between
these three variables during the first four quarters of impulse responses.5 The
restrictions to identify the structural shocks are consistent with theoretical
predictions (Fry and Pagan 2011) and follow other empirical studies in the
literature, although earlier studies differ in the types of variables and structural
shocks on which they focus.
• A positive global demand shock is assumed to increase global output growth,
global inflation, and oil price growth. This is consistent with similar
assumptions in earlier work. Melolinna (2015) assumes that a demand
shock raises output, inflation, and domestic interest rates. Charnavoki and
Dolado (2014) assume that a demand shock raises output, inflation, and
commodity prices. Gambetti, Pappa, and Canova (2005) assume that a
4 The selection of countries included in the estimation of the global inflation and output growth
factors reflects data availability. A balanced set of inflation series is available for 47 countries between
1970 and 2017 (accounting for 67 percent of global GDP in 2017), and that of output series is available
for 29 countries (accounting for 66 percent of global GDP in 2017). The results are robust to using a
smaller set of countries (25 countries, accounting for 63 percent of global GDP in 2017) with available
data for inflation and output growth. The global inflation factor behaves in line with (detrended) median
or average inflation, and the results are robust to defining global inflation as cross-country median or
average inflation. The results are also robust to using real oil prices or nominal energy prices (Annex 3.3).
5 The results are robust to imposing these sign restrictions for two quarters.
FIGURE 3.5 Global inflation and global output growth

Inflation comovement (captured by the contribution of a global factor to inflation variance)
has been stronger than output growth comovement. For inflation and output growth, this
comovement declined between 1970-85 and 1986-2000 but subsequently rebounded.
A. Global inflation factor B. Variance decomposition of inflation:

Contribution of the global factor over time
C. Global output factor D. Variance decomposition of output:

Contribution of the global factor over time
Source: World Bank.

Note: Global inflation and output factors are de-meaned. Shaded areas indicate global recessions and slowdowns (1975,
1982, 1991, 1998, 2000-01, and 2009).
A.B. The global inflation factor is extracted from 47 detrended national inflation rates using a dynamic factor model.
B.D. Variance shares of inflation (B) and output growth (D) accounted for by the global inflation factor (B) or global output
factor (D) are unweighted cross-country averages or medians.
C.D. Global output growth factor is extracted from 29 detrended national output growth rates using a dynamic factor model.
demand shock raises output, inflation and commodity prices. Gambetti,

Pappa, and Canova (2005) assume that a (government) demand shock
raises output, inflation, domestic interest rates, and money demand. Ferroni
and Mojon (2014) assume that a positive global demand shock raises
output, global inflation, and commodity prices and appreciates the
exchange rates of five Group of Seven (G7) economies and the Euro Area.
The results presented here are robust to imposing an additional (positive)
sign restriction on domestic interest rates.
• A positive global non-oil supply shock (hereafter “global supply shock”) is

assumed to raise global output and oil price growth but reduce global
inflation. This is consistent with assumptions used by other studies.
Charnavoki and Dolado (2014) assume that a negative non-commodity

supply shock raises input cost, reduces output and commodity prices, and
raises inflation. Gambetti, Pappa, and Canova (2005) assume that a positive
supply (technology) shock raises output but reduces inflation, domestic
interest rates, and money demand. Ferroni and Mojon (2014) assume that a
positive supply shock raises output, reduces inflation, and appreciates the
exchange rates of five G7 economies and the Euro Area.
• A positive oil price shock is defined as raising oil prices and global inflation
but depressing global output growth. This assumption also closely follows
other studies. Melolinna (2015), Charnavoki and Dolado (2014), and
Ferroni and Mojon (2014) assume that a positive cost (commodity price)
shock reduces output and raises commodity prices and inflation. Baumeister
and Peersman (2013) assume that a negative oil supply shock that raises the
price of oil reduces output and oil consumption.
Correlates of global shocks
The model identifies a series of global demand, global supply, and oil price
shocks from 1972 onward (Figure 3.6). These shocks have often been associated
with turning points in the global business cycle and sharp movements in oil
prices.
Global demand shocks. Negative global demand shocks were associated with
global recessions (1982, 1991, and 2009) and slowdowns (1998 and 2000-01).
Large positive global demand shocks often coincided with the year before the
global economy began to slide into a global recession or slowdown.
Oil price shocks. Positive oil price shocks were associated with oil supply
disruptions during the mid-1970s (1973-74), the Iranian Revolution (1979),
the Iran-Iraq War (1979-80), the First Persian Gulf War (1990), Venezuelan
unrest (2002-03), as well as militant attacks on pipelines in Iraq and Nigeria and
legal disputes over oil production in República Bolivariana de Venezuela (2007-
08) (Hamilton 2011; Baffes et al. 2015). Negative oil price shocks were
associated with the major OPEC decision to end production restraint amid
the development of new sources of oil supply (1986), the normalization of oil
prices after the First Persian Gulf War (1991), the global slowdown around the
Asian financial crisis (1997-98), and U.S. recessions (1990-91 and 2001). In
2014-16, OPEC’s decision to abandon production restraint amid rising output
from unconventional sources also constituted a negative oil price shock (Baffes
et al. 2015).6
6 Changes in global demand can also trigger oil price movements, such as the collapse in oil prices
during the global recession of 2009. In the framework used here, these would be captured as global
demand shocks.
FIGURE 3.6 Global demand, supply, and oil price shocks

Negative global demand shocks have been associated with global recessions and
slowdowns. Negative oil price and global supply shocks have been associated with major
supply disruptions and changes in OPEC policy. Negative global supply shocks have been
associated with the disruptions following the oil price spikes of 1973 and 1979 and the
global recessions or slowdowns in 1998, 2001, and 2009.
A. Global demand shocks B. Historical contribution of global demand

shocks to global inflation
C. Global supply shocks D. Historical contribution of global supply

shocks to global inflation
E. Oil price shocks F. Historical contribution of oil price shocks

to global inflation
Source: World Bank.

Note: The structural shocks and their historical contributions are estimated with the global factor-augmented vector
autoregression model discussed in Annex 3.3. OPEC = Organization of the Petroleum Exporting Countries.
A.C. Red-shaded areas indicate periods around global recessions and slowdowns (1975, 1982, 1991, 1998, 2000-01, and
2009).
C.E. Grey-shaded areas indicate periods around oil price spikes (1973-74, 1979, 1987-91, 1999-2002, and 2004-08).
E. Orange-shaded areas indicate periods around oil price plunges (1986, 1990-91, 1997-98, 2001, 2008, and 2014-16).
Global supply shocks. The widespread rise in inflation during the 1970s and
early 1980s has been partly attributed to negative global supply shocks that
compounded the impact of oil price shocks (Charnavoki and Dolado 2014). In
the 1990s, global supply shocks were modest. The global economic recovery
starting in the late 1990s into the mid-2000s, however, has been attributed to
positive global supply shocks associated with rising productivity linked to
advances in information technology and widespread trade liberalization
programs in EMDEs (Charnavoki and Dolado 2014).
Role of global shocks in global CPI inflation

Impact of global shocks on global inflation. A positive one-standard-deviation
global demand shock (corresponding to a 1.2 percentage point increase in
annual global output growth) raised annual global inflation by 0.9 percentage
point after one quarter and, cumulatively, by 5 percentage points after two years
(Figure 3.7).7 Similarly, a positive one-standard-deviation oil price shock
(corresponding to an increase in annual oil price growth of around 70
percentage points) raised annual global inflation by 4.4 percentage points after
two years. Although global supply shocks were modest over the sample period, a
positive one-standard-deviation global supply shock reduced annual global
inflation by 2.6 percentage points within two years.
Contributions of global shocks to global inflation variation. Global demand
shocks and oil price shocks, in almost equal measure, have been the main drivers
of global inflation variation since the 1970s (Figure 3.8). These two types of
shocks together have accounted for about 80 percent of the variation in global
inflation since the 1970s, each contributing about 40 percent. In contrast to
global inflation, the variance of global output growth has been driven mostly by
global demand shocks (accounting for 60 percent of growth variance during the
full sample period), with a more modest role for oil price shocks (accounting for
22 percent of growth variation). As would be expected, fluctuations in oil prices
mostly reflect shocks specific to oil prices (accounting for 76 percent of oil price
variation) over the sample period.8
Evolution of contributions of global shocks to global inflation variation.
Global shocks differed in their variability over the three subperiods. This, as well
7 The direction of the impact of global shocks on inflation is determined by the sign restrictions for the
first four quarters, but their magnitude and persistence remain of interest.
8 These numbers refer to the variance decompositions for one-year-ahead forecast errors of global
inflation. Over a medium- to long-term (5-10 years) forecasting horizon, the variance contribution of the
global demand shocks (44 percent) is slightly greater than that of oil price shocks (38 percent), since
global demand shocks are somewhat more persistent than oil price shocks. This is consistent with the
results of Melolinna (2015) for the Euro Area, the United Kingdom, and the United States. Melolinna
(2015) finds similar responses of inflation to global shocks over the past four decades.
FIGURE 3.7 Impact of global shocks on global inflation

A positive one-standard-deviation global demand shock raised global inflation by 0.9
percentage point within one quarter and, cumulatively, by 5 percentage points within two
years. A positive one-standard-deviation oil price shock raised global inflation by 4.4
percentage points within two years. A positive one-standard-deviation global supply shock
reduced global inflation by 2.6 percentage points within two years.
A. Impulse response of global inflation: B. Impulse response of global inflation:

Global demand and oil price shocks Global supply shocks
Source: World Bank.

Note: The results are estimated with the global factor-augmented vector autoregression model discussed in Annex 3.3.
The cumulative impulse response of global inflation to a one-standard-deviation increase in global oil prices (corresponding
to 70 percentage points higher oil price growth), global supply, or global demand (corresponding to 1.2 percentage points
higher output growth) on impact, after one year, and after two years. Orange diamonds indicate the median responses and
blue or red bars indicate the 16th-84th percentile confidence intervals.
as the changing responses of global inflation to these shocks, was reflected in

shifts in the contribution of global shocks to global inflation variability over
time. In particular, the contribution of supply shocks to global inflation
variability has receded over time, while that of global demand shocks has
strengthened (Figure 3.8). Global supply shocks were the main source (42
percent) of, in this case modest, global inflation variability during 1986-2000.
Since 2001, however, the variance share of global supply shocks has fallen to 7
percent.
Conversely, the contribution of global demand shocks to global inflation
variability has grown to 60 percent since 2001, partly reflecting the global
recession of 2009 and the global slowdown of 2001. During the past decade,
2008-17, global demand shocks accounted for three-quarters of global inflation
variation. However, the 2014-16 oil price plunge had a significant impact on
global inflation: oil price shocks have accounted for 57 percent of global
inflation variability since 2010, whereas global demand shocks have accounted
for only 30 percent.9
9 This is in line with ECB (2015); Sussman and Zohar (2015); and Berganza, Borallo, and del Río
(2016). For instance, ECB (2015) estimates that the decline in Euro Area headline CPI inflation to zero
in 2015, from 1.4 percent in 2013, was mostly driven by energy price developments.
FIGURE 3.8 Impact of global shocks on global inflation over time

Oil price shocks and global demand shocks, in approximately equal measure, have been
the main sources of short-term variations in global inflation since the 1970s. The role of
supply shocks receded in the two most recent decades, while that of global demand
shocks strengthened. Since 2010, oil price shocks have been the main driver of global
headline inflation.
A. Impulse response of global inflation B. Variance decompositions of global

inflation, output growth, and oil prices
C. Variance decompositions of global inflation D. Variance decompositions of global inflation

over time since 2010
Source: World Bank.

Note: Cumulative impulse responses to one-standard-deviation shocks after two years (A) and variance decompositions
(B-D) estimated by the global factor-augmented vector autoregression model discussed in Annex 3.3.
A. Cumulative response of global inflation after two years to a one-standard-deviation increase in global oil prices
(corresponding to 70 percentage points higher oil price growth), global supply, or global demand (corresponding to 1.2
percentage points higher output growth). Confidence interval indicates 16th-84th percentiles.
D. Full sample period indicates 1970-2017.
Role of global shocks in different measures of global inflation

The importance of oil prices for inflation partly reflects the sizable share of
energy in consumer baskets and, therefore, headline CPI inflation (Altansukh et
al. 2017). On average, energy accounts for around 20 percent of headline CPI
weights.10 To explore the role of energy and other tradables in the contribution
of global shocks to inflation, the same FAVAR exercise is conducted for global
core CPI inflation and global producer price inflation. Producer price indexes
10 This estimate is based on the average share of housing, water, electricity, gas, and other fuels in CPI
baskets for 71 advanced economies and EMDEs (source: OECD).

(PPIs) tend to have a larger tradables content than headline CPI indexes,
whereas core CPI indexes tend to have a smaller tradables content than headline
CPI indexes (Chapter 2).11
Impact of global shocks on global core and PPI inflation. Global PPI inflation
is more sensitive to global demand shocks than global headline and CPI
inflation. A positive one-standard-deviation global demand shock would raise
global PPI inflation by almost twice as much as it raises global CPI—headline or
core—inflation over the following two years (Figure 3.9). Global PPI inflation
appears to be also somewhat (one-and-a-half to two times) more sensitive, albeit
not statistically significantly more, to oil price shocks than global CPI—headline
or core—inflation. All three measures respond broadly similarly to a global
supply shock.
Relative contributions of global shocks to inflation variability. The

contribution of global demand shocks to global inflation variation was similar
across all three measures (45-50 percent), but the relative contributions of oil
prices and global supply shocks differed (Figure 3.9). The smaller energy
content may account for the modest contribution of oil price shocks to global
core CPI inflation variation (20 percent)—about half the contribution to
headline CPI inflation variation. Less affected by energy and other tradables
price shocks, core CPI inflation reflects an important role for global supply
shocks: global productivity shocks or their cross-country spillovers, as captured
by global supply shocks, appear to have been the main source of variation in
core CPI inflation (38 percent), more than twice as much as for PPI inflation
(14 percent) and headline CPI inflation. Over the past four to five decades, the
impact of global demand, supply, and oil price shocks on global core inflation
has become steadily more muted, with global demand shocks being the
predominant source of global shocks. This may reflect better anchoring of
inflation expectations associated with the shift toward more resilient monetary
policy frameworks (Chapter 4).
Drivers of domestic inflation

The previous section establishes that global demand shocks and oil price shocks
have been the main drivers of the variation in global inflation. This section
examines the roles of global shocks along with domestic shocks in explaining the
variation in domestic inflation.
11 For example, the share of tradable goods and services in the United States is the greatest for the PPI
(54 percent), followed by headline CPI (53 percent) and core CPI (15 percent, U.S. Bureau of Labor
Statistics).
FIGURE 3.9 Impact of global shocks on global inflation: Various

inflation measures
Global PPI inflation responds more strongly than other inflation measures to global
demand and oil price shocks. Oil price shocks contributed about 20 percent—half as
much as for headline inflation—to global core inflation variance. Meanwhile, the variance
share of supply shocks in total variation in core CPI is larger than in other measures of
inflation.
A. Impulse responses of headline CPI, core B. Variance decompositions of headline CPI,

CPI and PPI inflation core CPI and PPI inflation
Source: World Bank.

Note: Cumulative impulse responses to positive one-standard-deviation shocks after two years (A) and variance
decompositions (B) are estimated by the global factor-augmented vector autoregression model discussed in Annex 3.3, for
the full sample period 1970-2017. CPI = consumer price index; PPI = producer price index.
A. Blue bars indicate 16th-84th percentile confidence intervals.
Methodology
Model and data. The FAVAR model above is expanded to include four
country-specific variables, along with three global variables (global inflation,
global real output growth, and oil prices): headline CPI inflation, output
growth, nominal interest rates (three-month Treasury bill rates or monetary
policy rates), and nominal effective exchange rates. The extension of the model
here follows earlier work by Forbes, Hjortsoe, and Nenova (2017, 2018) and
Conti, Neri, and Nobili (2015). All the variables are seasonally adjusted
quarterly growth rates (except interest rates) between 1970 and 2017. The
model is estimated on a country-by-country basis for 29 advanced economies
and 26 EMDEs. For details of the model and data set, see Annex 3.3.
Identification of shocks. On top of the three global shocks (global demand,

global supply, and oil price shocks) identified in the global block of the FAVAR
model, four types of domestic shocks are specified: domestic supply, domestic
demand, monetary policy, and exchange rate shocks.12 The shocks are identified
under the following assumptions:
12 Gambetti, Pappa, and Canova (2005), for instance, show that a combination of technology, demand,
and monetary shocks explains variations in the persistence and volatility of inflation in G7 countries.
• For global inflation, global output growth, and oil price growth, the same
sign restrictions described in the previous section are imposed.
• Global variables are assumed to affect country-specific variables
contemporaneously (without any sign restrictions), but the feedback from
country-specific variables to global variables is assumed to be delayed by at
least one quarter (block zero restriction).
To identify domestic shocks, a set of sign restrictions is imposed on the
contemporaneous impulse responses of country-specific variables (Annex 3.3):13
• A positive domestic demand shock is assumed to raise domestic output
growth and inflation. This is consistent with, but less restrictive than, the
sign restrictions of Gambetti, Pappa, and Canova (2005), who also impose
the assumption that a positive demand shock raises money demand; Forbes,
Hjortsoe, and Nenova (2018) and Conti, Neri, and Nobili (2015), who
also impose the assumptions that a demand shock raises interest rates and
appreciates the domestic currency; and Ferroni and Mojon (2014), who
also assume that a positive demand shock depreciates the domestic
currency. The results presented here are robust to an additional positive
sign restriction on the response within one quarter of short-term interest
rates to an increase in the positive domestic demand shock.
• A positive domestic supply shock raises domestic output growth but reduces
inflation. This is consistent with the sign restrictions of Forbes, Hjoertsoe,
and Nenova (2018) and Gambetti, Pappa, and Canova (2005), who also
impose a restriction that a positive supply shock reduces interest rates and
money demand, and of Ferroni and Mojon (2014), who also assume that a
positive supply shock appreciates the exchange rate.
• A contractionary (positive) monetary policy (or short-term rate) shock triggers
nominal effective appreciation, lower output growth, and lower inflation.
This is consistent with the sign restrictions of Forbes, Hjoertsoe, and
Nenova (2018) and Conti, Neri and Nobili (2015). Gambetti, Pappa, and
Canova (2005) impose a restriction that a monetary policy shock that raises
interest rates lowers output, inflation, and money demand.
• The impact of a positive exchange rate shock (corresponding to an
appreciation of the domestic currency) is unrestricted. Forbes, Hjoertsoe,
and Nenova (2018) impose the restriction that a positive exchange rate
13 Conti, Neri, and Nobili (2015) and Canova and Paustian (2011) argue that sign restrictions imposed
on the contemporaneous relationships among variables are robust to several types of model
misspecification. The results here are also robust to imposing sign restrictions for two quarters, as in
Forbes, Hjortsoe, and Nenova (2017).
shock reduces inflation and interest rates. Other authors do not impose sign
restrictions on responses to exchange rate shocks (Ferroni and Mojon 2014;
Conti, Neri, and Nobili 2015; Gambetti, Pappa, and Canova 2008;
Melolinna 2015).
The sign restrictions imposed in this chapter are therefore standard except in the
identification of domestic demand shocks and exchange rate shocks. Some
studies put sign restrictions on the impact of domestic demand shocks on
domestic interest rates (or monetary policy rates), and others do not. For lack of
a clear economic motivation for imposing this restriction on all the countries,
this chapter refrains from imposing sign restrictions. That said, the results are
robust to the imposition of additional sign restrictions, as done in several other
studies (Annex 3.3). Separately, the sign restrictions used here could lead to
ambiguity between domestic monetary shocks and domestic demand shocks
(Fry and Pagan 2011). In practice, however, the number of Bayesian draws that
are subject to such ambiguity (that is, where all variables have exactly the same
directional response to the two shocks) is less than 1 percent for virtually all
countries. Finally, also for lack of economic motivation, no sign restrictions are
imposed on exchange rate responses. This could also potentially create
ambiguity between exchange rates and other shocks. However, the results are
robust to eliminating any potentially ambiguous draws.
Role of global shocks in domestic inflation

Overall impact of global shocks on domestic inflation. Global shocks had a
significant impact on domestic inflation, although the impact was somewhat
more muted than for global inflation (Figure 3.10). A negative one-standard-
deviation global demand shock (about one-third the size of the average negative
demand shock of 2008-09) or oil price shock (about the size of the average
negative oil price shock of 2014-15) was associated with lower inflation in the
median country by 0.5 percentage point after a quarter and around 1.5
percentage points after two years on a cumulative basis. A negative one-
standard-deviation global supply shock raised domestic inflation by around 0.4
percentage point after a quarter, and 1.1 percentage points after two years.
Broad-based impact of global shocks on domestic inflation. The impact of
global shocks on domestic inflation was statistically significant for most
countries. In 90 percent of the countries, domestic inflation responded
significantly within a quarter to global demand, global supply, and oil price
shocks. In three-quarters of the countries, the cumulative responses of domestic
inflation after two years to global demand shocks were statistically significant.
In more than 60 percent of the countries, the cumulative responses to
global supply or oil price shocks after two years were statistically significant
(Figure 3.10).
FIGURE 3.10 Impact of global shocks on domestic inflation

Domestic inflation responded strongly—and in the majority of countries statistically
significantly—to global shocks.
A. Impulse response of domestic inflation to B. Impulse response of domestic inflation to

global demand and oil price shocks global supply shocks
C. Impulse response of domestic inflation: D. Share of countries with statistically

Advanced economies and EMDEs significant impulse response
Source: World Bank.

Note: The results are based on the country-specific factor-augmented vector autoregression models discussed in Annex
3.3, estimated for 29 advanced economies and 26 EMDEs for 1970-2017. EMDEs = emerging market and developing
economies.
A.-C. The figures present cumulative impulse responses after two years of domestic inflation to positive one-standard-
deviation global shocks. Orange diamonds indicate medians and blue or red bars indicate the 25th-75th percentiles of
country-specific impulse responses.
D. Share of countries in each group with statistically significant (within 16-84 percent confidence band) cumulative
response after two years to a one-standard-deviation shock to global demand, supply, and oil prices.
Impact of global shocks on domestic inflation in advanced economies and

EMDEs. The impulse responses of domestic inflation to global shocks were
comparable across the two groups of countries, although they ranged much
more widely among EMDEs than advanced economies (Figure 3.10). Inflation
in the median country in both groups increased by around 1.5 percentage points
two years after a positive one-standard-deviation oil price shock and decreased
by around 1 percentage point two years after a positive one-standard-deviation
global supply shock.14 The response of domestic inflation after two years in the
14 Using a panel of 72 countries, Choi et al. (2018) also find similar point estimates for advanced
economies and EMDEs, although the effect of oil price shocks is more precisely estimated for advanced
economies than for EMDEs.
median EMDE to a positive one-standard-deviation global demand shock was

somewhat smaller (1 percentage point) than in the median advanced economy
(1.8 percentage points). However, the range of impact among EMDEs was
much wider (from 0.5 to 4 percentage points), such that the difference between
advanced economies and EMDEs was not statistically significant.
Relative contribution of global shocks to domestic inflation variation. In the
full sample period, global shocks accounted for over a quarter of domestic
inflation variance (27 percent) in the median country, but with wide
heterogeneity (contributions ranging from 0 to 70 percent).15 As found by other
studies (Conti, Neri, and Nobili 2015; Parker 2018), the main global shocks
transmitted to domestic inflation were global demand shocks and oil price
shocks. In the median country, they accounted for 14 and 8 percent,
respectively, of domestic inflation variation (Figure 3.11).
Consistent with the results presented in Chapter 2, the contribution of global
shocks to domestic inflation variation was considerably larger (33 percent
median) in advanced economies—with global demand shocks and oil price
shocks important—than in EMDEs (14 percent). The greater contribution of
global shocks to advanced economy inflation may reflect their stronger global
trade and financial linkages, more deeply integrated supply chains, more
diversified export bases, and more similar monetary policy regimes. EMDEs
are a more heterogeneous group of countries that may be expected to respond
in a widely heterogeneous manner to external shocks (Cárdenas and Levy-
Yeyati 2011).
Evolution of the role of global shocks in domestic inflation

Country-specific FAVAR models are estimated over the three subperiods of
1970-85, 1986-2000, and 2001-17. The results suggest that the role of global
shocks in domestic inflation has strengthened considerably since 2001 in an era
of rapidly deepening global trade and financial integration (Chapter 1).
Evolution of the impact of global shocks on domestic inflation. The response
of domestic inflation to global shocks has risen since 2001, after falling slightly
during 1986-2000 (Figure 3.11). The impulse responses of domestic inflation to
oil price shocks during 2001-17 were similar to those in the 1970s and early
1980s, after falling to virtually nil during 1986-2000. The impulse responses to
global demand shocks were larger during 2001-17 than during 1986-2000 but
somewhat more moderate than those during 1970-85, although not statistically
15 In Chapter 2, the global inflation factor accounts for 12 percent of domestic inflation variation
during 1970-2017. This share cannot be easily compared with the results reported here because of the
differences in samples and methodologies. The estimation in Chapter 2 reflects a much larger sample
than here where the estimation requires quarterly data.
significantly so. Finally, since the mid-1980s, the impulse responses to global
supply shocks have been modest, and significantly smaller than during the
1970s and early 1980s.
Evolution of the relative contribution of global shocks to domestic inflation

variation. The contribution of global shocks to domestic inflation variation
depends on the responsiveness of domestic inflation to global shocks and the
magnitude and frequency of global shocks.16 Since 2001, the contribution of
global shocks to domestic inflation variation has grown significantly (to 43
percent, from 20-23 percent previously), and in all country groupings (to more
than one-half in advanced economies and one-quarter in EMDEs), as a result of
considerably larger global demand and oil price shocks. To a large extent, this
may reflect the impacts of the global financial crisis, propagated through global
supply chains and trade networks, and the 2014-16 oil price plunge (Baffes et al.
2015; Nguyen et al. 2017). Nevertheless, the contribution of global supply
shocks has decreased over time, from 10 percent during 1970-85 to less than 5
percent since 1986.
Domestic drivers of domestic inflation
Notwithstanding the increase since 2001 in the contribution of global shocks to

domestic inflation variation, domestic shocks remained the main source of
domestic inflation variation. Over the full sample period, domestic shocks
accounted for about three-quarters of domestic inflation variation in the median
country (about six-sevenths in the median EMDE and two-thirds in the median
advanced economy). Domestic supply shocks were the largest domestic source
of inflation variation. In EMDEs, for example, domestic supply shocks alone
contributed more than half as much to domestic inflation variation as all global
shocks combined.
An abundant literature has explored the role of various domestic drivers of

inflation in a wide range of country samples and methodologies (Annex 3.1).
The methodology used in this chapter quantifies the four most commonly
discussed domestic shocks (domestic demand and supply, monetary policy, and
exchange rates) in a consistent framework after controlling for global shocks.
16 The evolution of the volatility of structural shocks can be indirectly measured by the standard
deviation of the structural shocks for the subperiods of interest. The standard deviation of oil price shocks
halved from 1970-85 (1.45 percent) to 1986-2000 (0.78 percent) and remained low during 2001-17
(0.72 percent). The standard deviation of global demand shocks also decreased from 1970-85 to 1986-
2000 (from 1.06 to 0.79 percent) but increased again to 1.1 percent during 2001-17. The standard
deviation of global supply shocks evolved in a similar pattern to that of oil price shocks.
FIGURE 3.11 Contributions of global shocks to domestic inflation

Global shocks accounted for around a quarter of domestic inflation variation, but
considerably more in advanced economies (one-third) than in EMDEs (one-seventh). Since
2001, however, this contribution has grown in all country groups—to more than one-half in
advanced economies and one-quarter in EMDEs—as a result of considerably larger global
demand shocks.
A. Contribution of total global shocks to B. Contribution of total global shocks to

domestic inflation: 1970-2017 domestic inflation: 2001-17
C. Contribution of global shocks to domestic D. Impulse response of domestic inflation to

inflation variation over time global shocks over time
E. Contribution of global shocks to domestic F. Contribution of global shocks to domestic

inflation variation over time: Advanced inflation variation over time: EMDEs
economies
Source: World Bank.

A.-C., E., F. Median shares of country-specific inflation variance accounted for by global shocks (global demand, global
supply, and oil prices) based on the country-specific factor-augmented vector autoregression models discussed in Annex
3.3, estimated for 29 advanced economies and 26 EMDEs for 1970-2017, unless otherwise noted.
D. Cumulative impulse responses of domestic inflation after two years, following one-standard-deviation shocks. Orange
diamonds indicate medians and blue bars indicate the 25th-75th percentile of country-specific impulse responses.
FIGURE 3.12 Correlates of domestic shocks

Negative domestic demand shocks were associated with domestic recessions, especially
when they coincided with global recessions. Negative supply shocks were associated with
low (or negative) productivity growth and were most pronounced around financial crises.
Positive (contractionary) monetary policy shocks were associated with interest rate hikes,
especially during economic downturns, and accommodative monetary policy shocks were
associated with interest rate cuts. Exchange rate shocks were most pronounced during
currency crises but were also sizable during debt and banking crises.
A. Domestic demand shocks B. Domestic supply shocks
C. Monetary policy shocks D. Exchange rate shocks
Source: Economic Cycle Research Institute; World Bank.

Note: Orange diamonds indicate median and blue bars indicate the 25th-75th percentile of identified shocks in the full
sample period 1970-2017. The results are based on the country-specific factor-augmented vector autoregression
estimation discussed in Annex 3.3, estimated for 29 advanced economies and 26 emerging market and developing
economies.
A.C. For 21 countries, business cycle turning points are used. For the other countries, the turning points are identified as in
Harding and Pagan (2002).
B. Productivity growth defined as total factor productivity (TFP) growth the from Penn World Tables. “High” (“low”) indicates
the year in which TFP growth is in the highest (lowest) quartile for 1970-2017.
C. Positive (interest rate “hikes”) and negative (interest rate “cuts)” monetary policy shocks exceeding one standard
deviation.
D. Currency, banking, and debt crises as defined in Laeven and Valencia (2013).
Correlates of domestic shocks
The model identifies a series of domestic supply, domestic demand, monetary

policy, and exchange rate shocks from 1972 onward. These estimated shocks
have tended to be associated with the turning points of domestic business cycles,
dynamics of productivity growth, monetary policy decisions, and developments
during financial crises.
Domestic demand shocks. Negative domestic demand shocks have been closely
associated with domestic recessions (Figure 3.12). The demand shocks were
more pronounced when domestic recessions overlapped with global recessions.
Global recessions may have amplified domestic recessions by generating
spillovers through trade and financial links. Ferroni and Mojon (2014) also find
that Euro Area disinflation during 2008-09 was largely a reflection of negative
demand shocks caused by the global financial crisis.
Domestic supply shocks. Negative supply shocks appear to be associated with

low (or negative) productivity growth. They were also particularly pronounced
around financial crises. Indeed, Forbes, Hjortsoe, and Nenova (2018) identify
strong negative supply shocks in the United Kingdom during the global
financial crisis. Currency, debt, and banking crises may have caused severe
disruptions to economic activity that were reflected in these negative supply
shocks.
Monetary policy shocks. Accommodative monetary policy shocks were

associated with policy interest rate cuts. Similarly, contractionary monetary
policy shocks were associated with policy rate hikes, especially when they were
implemented around business cycle troughs. Many monetary policy rate hikes
around business cycle peaks were not identified as contractionary, suggesting
that they were largely an endogenous response to inflationary pressures. The
model correctly identifies the aggressive U.S. monetary policy tightening in
1979-82 (Annex 1.4 in Chapter 1) as well as the monetary policy loosening in
major Euro Area countries in the early to mid-2010s in response to the Euro
Area sovereign debt crisis (Conti, Neri, and Nobili 2015).
Exchange rate shocks. As expected, exchange rate shocks were most pronounced
during currency crises. They were also significant during debt and banking
crises, but they were about one-fifth and one-half, respectively, of the size of
exchange rate shocks during currency crises.
Role of domestic shocks in explaining domestic inflation
Overall impact of domestic shocks on domestic inflation. The estimated

response of domestic inflation to domestic demand shocks is slightly stronger
than its response to global demand shocks: a one-standard-deviation positive
domestic demand shock raised annual domestic inflation by 1.6 percentage
points within two years (Figure 3.13).17 In the median country, domestic supply
17 Many studies document a growing role for domestic demand shocks in explaining domestic inflation
variation (Leeper, Sims, and Zha 1996; Domaç and Yücel 2005; Ahmad and Pentecost 2012; Nguyen et
al. 2017).
FIGURE 3.13 Impact of domestic shocks on domestic inflation

Domestic inflation responded somewhat more strongly to domestic demand shocks than
to global demand shocks. In the median country, domestic supply shocks had about twice
the impact of global supply shocks on domestic inflation. The impact of monetary policy
shocks was comparable to that of domestic demand shocks.
A. Impulse response to global and domestic B. Impulse response to global and domestic
demand shocks supply shocks
C. Impulse response to domestic shocks: D. Share of countries with statistically

Advanced economies and EMDEs significant impulse response
Source: World Bank.

Note: AEs = advanced economies; EMDEs = emerging market and developing economies.
A.-C. Cumulative impulse responses of domestic inflation on impact, after one (A, B) or two (A, B, C) years to
one-standard-deviation shocks based on the country-specific factor-augmented vector autoregresson models discussed in
Annex 3.3, estimated for 29 AEs and 26 EMDEs for 1970-2017. Diamonds show median and blue or red bars indicate
25th-75th percentiles of country-specific results. In the median country, a positive one-standard-deviation domestic
demand shock increases domestic output growth by 1.6 percentage points, a positive supply shock decreases domestic
inflation by 1.1 percentage points, a positive (contractionary) monetary policy shock increases short-term interest rates
(or policy rates) by 0.27 percentage point, and a positive exchange rate shock drives a 15 percentage point increase
(appreciation) in nominal effective exchange rates.
D. Share of countries with a statistically significant (at the 16th-84th percentile range) cumulative response of domestic
inflation after two years.
shocks had about twice the impact of global supply shocks on domestic
inflation. A one-standard-deviation positive domestic supply shock reduced
domestic inflation by about 2.5 percentage points after two years.18 The impact
of monetary policy shocks was comparable to that of domestic demand shocks: a
one-standard-deviation increase in short-term interest rates reduced domestic
18 A role for supply shocks has been found by Globan, Arčabić, and Sorić (2015); Ahmad and
Pentecost (2012); and Nguyen et al. (2017).

inflation by 2 percentage points after two years.19 The impact of exchange rate
shocks was smaller (less than 1 percentage point after two years) than that of
other domestic shocks.
Broad-based impact of domestic shocks on domestic inflation. The effects of

domestic demand, supply, and monetary policy shocks were broad-based: the
cumulative impacts after two years were statistically significant in 92 percent of
the countries. As explored in Chapter 5, monetary shocks are an important
source of exchange rate fluctuations and are often associated with a larger
exchange rate pass-through to domestic prices than are other types of shocks. In
contrast, few countries display a statistically significant response of domestic
inflation to pure exchange rate shocks, in part due to the wide range of sources
of exchange rate shocks and the wide range of country characteristics that
determine the effects of such shocks on inflation.20 Possibly reflecting the higher
level and volatility of inflation in EMDEs, the response of domestic inflation to
domestic shocks was stronger in the median EMDE than in the median
advanced economy, although the difference was not statistically significant.
Relative contribution of domestic shocks to domestic inflation. In the median
country in the full sample period, domestic shocks contributed more than three
times as much as global shocks to domestic inflation variation. Domestic shocks
accounted for 67 percent of the variation in domestic inflation in advanced
economies, and 85 percent in EMDEs (Figure 3.14). In contrast to global supply
shocks, which played a limited role in global and domestic inflation variation,
domestic supply shocks accounted for a greater variance share of domestic
inflation (26 percent) than every other type of domestic shock and, in EMDEs,
a greater share than all global shocks combined. The predominant role of
domestic supply shocks is consistent with previous studies.21
Domestic demand shocks and monetary policy shocks each accounted for
around 15 percent and exchange rate shocks for about 17 percent of domestic
19 The transmission of monetary policy has been extensively documented, especially for advanced
economies. The recent literature includes Disyatat and Vongsinsirikul (2003); Maćkowiak (2007);
Osorio and Unsal (2013); Elbourne and Haan (2009); Globan, Arčabić, and Sorić (2015); Tena and
Salazar (2008); Mallick and Sousa (2012); Mishra, Montiel, and Sengupta (2016); Ngalawa and Viegi
(2011); and Nguyen et al. (2017).
20 In part, the wide range of impulse responses for exchange rate shocks reflects that, being largely
unrestricted, they capture a large variety of shocks.

21 Supply shocks, which tend to be associated with changes in relative prices, have tended to be more
important than shifts in demand. Nguyen et al. (2017) find that the main drivers of inflation dynamics in
Sub-Saharan African countries in the previous 25 years were shocks to domestic supply, the exchange
rate, and monetary variables. In 33 mostly EMDE countries between 1986 and 2010, Osorio and Unsal
(2013) estimate that domestic shocks explain the majority (around 70 percent) of inflation variation. For
European Union countries, the evidence is mixed. Vašíček (2011) estimates that global shocks were the
main drivers of inflation in the Czech Republic, Hungary, Poland, and the Slovak Republic during
1998-2007.
FIGURE 3.14 Evolution of the impact of domestic shocks on

inflation
During 1970-2017, domestic supply shocks explained about one-quarter of domestic
inflation variation in advanced economies and EMDEs. Other domestic shocks contributed
less and in almost equal measure to domestic inflation variation. The contribution of
domestic shocks, especially exchange rate and domestic supply shocks, to domestic
inflation variation has decreased over time.
A. Contribution of global and domestic shocks B. Contribution of global and domestic

to domestic inflation shocks to domestic inflation, over time
C. Contribution of global and domestic D. Contribution of global and domestic

shocks to domestic inflation over time: shocks to domestic inflation over time:
Advanced economies EMDEs
E. Impulse response of domestic inflation: F. Impulse response of domestic inflation:

Domestic demand and supply shocks over Monetary policy and exchange rate shocks
time over time
Source: World Bank.

Note: Median share of country-specific inflation variance accounted for by domestic shocks (domestic demand, supply,
exchange rates, and interest rates) based on the country-specific factor-augmented vector autoregression models
discussed in Annex 3.3, estimated for 29 advanced economies and 26 EMDEs for 1970-2017. EMDEs = emerging market
and developing economies.
E.F. Orange diamonds indicate the median and blue bars indicate the 25th-75th percentile of country-specific impulse
responses. Cumulative impulse responses after two years for 1970-85, 1986-2000, and 2001-17.
inflation variation. The variance share of domestic supply shocks was somewhat
more pronounced in EMDEs (30 percent) than in advanced economies (25
percent). In advanced economies and EMDEs, the other three types of domestic
shocks contributed in broadly equal measure (but always more in EMDEs than
in advanced economies) to domestic inflation variation.
Evolution of the role of domestic shocks in domestic inflation
Evolution of the impact of domestic shocks on domestic inflation. Since the

mid-1980s, the sensitivity of domestic inflation to domestic shocks has declined
(Figure 3.14). During 2001-17, the responses of domestic inflation to all four
types of domestic shocks were half or less of those during 1970-85. These
declines largely occurred during the Great Moderation and, in contrast to the
response to global shocks, there has not been a rebound in the response to
domestic shocks since 2001. The impact of exchange rate shocks, which was
modestly negative during 1970-85, all but disappeared during 2001-17. It is
possible that a gradual improvement in the anchoring of inflation expectations
has contributed to this lower responsiveness of inflation to domestic shocks. The
role of inflation expectations is explored in detail in Chapter 4.
Evolution of the relative contribution of domestic shocks to domestic inflation

variation. Since 2001, the contribution of domestic shocks to domestic inflation
variation has declined to 53 percent, from 77-80 percent during the preceding
decades. This decline has affected all types of domestic shocks broadly similarly.
As a result, domestic supply shocks have remained the main source of domestic
inflation variation since 2001, accounting for 16 percent of total domestic
inflation variation. This broad-based decline in the contribution of all domestic
shocks since 2001 is particularly evident in EMDEs. In contrast, in advanced
economies, the contribution of supply shocks has shrunk considerably more
than that of other shocks, such that, since 2001, domestic supply shocks have
contributed less to advanced economy domestic inflation than monetary policy
shocks.
Cross-country variation in the role of global and domestic

shocks in domestic inflation
Role of global shocks. The role of global factors in explaining domestic inflation
has varied widely across countries. The median contribution of global shocks
was considerably larger in countries that were open to global trade and finance
and were commodity importers (Figure 3.15). Monetary policy and exchange
rate regimes also mattered: global shocks were more important inflation drivers
FIGURE 3.15 Contribution to domestic inflation, by country groups

Global shocks have been a more important source of domestic inflation movements in
countries with stronger global trade and financial linkages, greater dependence on
commodity imports, and fixed exchange rate regimes.
Global demand Oil price Global supply Exchange rate Monetary policy
Domestic supply Domestic demand
A. All countries: By trade and financial B. EMDEs: By trade and financial openness
openness
C. All countries: By monetary policy and D. EMDEs: By monetary policy and exchange
exchange rate frameworks rate frameworks
Source: Ilzetzki, Reinhart, and Rogoff 2017; World Bank.

Note: Median share of country-specific inflation variance accounted for by domestic shocks (domestic demand, supply,
exchange rates, and interest rates) and global shocks based on country-specific factor-augmented vector autoregression
models discussed in Annex 3.3, estimated for 29 advanced economies and 26 EMDEs for 1970-2017. EMDEs = emerging
market and developing economies; GDP = gross domestic product; IT = inflation targeting.
A.B. Countries with “high” capital openness are defined as those above the median, as in Chinn and Ito (2017); all others
are considered to have “low” capital openness. Countries with “high” trade openness are defined as those with trade-to-
GDP ratios above the median; all others are considered to have “low” trade openness.
C.D. IT regimes are defined as in IMF (2016). Flexible exchange rate regimes (Float) are defined as freely floating and
managed floating exchange rate regimes, as defined in Ilzetzki, Reinhart, and Rogoff (2017). All other regimes are defined
as pegged exchange rate regimes (Peg). See the Appendix for more details on country characteristics.
in countries without inflation targeting and fixed exchange rate regimes.22 In

EMDEs, the median contribution of global shocks to domestic inflation
variances in countries without inflation targeting and fixed exchange rate
22 These results do not qualitatively change when the results are based on averages across countries.
They are mostly consistent with earlier studies.

regimes, and with greater trade and financial openness was more than twice that
in other EMDEs. The variance share of global demand shocks was particularly
sizable (20 percent or more) for EMDEs with above-median trade and financial
openness, with fixed exchange rate regimes, and without inflation targeting
regimes.23 The variance share of global oil price shocks was particularly sizable in
countries, especially EMDEs, that were commodity importers, open to trade
and international finance, with fixed exchange rates, and without inflation
targeting regimes.24 The variance share of global supply shocks was particularly
large in EMDEs with less independent central banks.
Conclusion
Over the past decade—since the global financial crisis of 2008-09 and the oil
price plunge of 2014-16—global inflation has been exceptionally low. The
results in this chapter suggest that the recent decline in global inflation stemmed
in part from the severe global recession and that was prolonged by the oil price
plunge. Global demand shocks have accounted for most of the variation in
global inflation variation since 2008, and oil price swings have accounted for 60
percent since 2010.
More broadly than the post-crisis period, this chapter has explored
systematically, in a unified framework, the roles of domestic and global demand,
supply, and commodity price shocks, as well as monetary policy and exchange
rate shocks, in explaining movements in global and domestic inflation. The
following are the key findings.
First, this chapter highlights the role of global demand shocks and oil price
shocks in explaining variations in global inflation since 1970. Oil price shocks
and global demand shocks together contributed 80 percent (about 40 percent
each) to the variation in global inflation in this period. The roles of global
demand shocks and oil price shocks have strengthened considerably over time,
while that of global supply shocks has receded.
Second, global shocks have accounted for about one-quarter of domestic
inflation variation since the 1970s, but with wide heterogeneity across countries.
23 Bianchi and Civelli (2015) find that the impulse responses of inflation to global slack are higher in
countries that are more open to trade and with higher business cycle integration. Theoretical
considerations developed by Martínez-Garcia and Wynne (2010) suggest that inflation is less responsive
to domestic slack in countries that are more open to trade. Andrews, Gal, and Witheridge (2018) also
find that a high level of global value chain integration can strengthen the transmission of global shocks by
accentuating the impact of global economic slack on domestic inflation.
24 Berganza, Borallo, and del Río (2016) find that the direct effects of falling oil prices have been
greater in countries with a larger share of oil in the CPI and higher energy taxation (usually in the form of
unit tax rates), as well as currency depreciations after the oil price drop.
The role of global shocks was considerably larger (33 percent) in the median
advanced economy—with global demand shocks and oil price shocks about
equally important—than in the median EMDE (14 percent) where only global
demand shocks played a major role.
Third, it follows that domestic shocks have accounted for about three-quarters
of domestic inflation variation and more in EMDEs. In contrast to global supply
shocks, which played a limited role in global and domestic inflation variation,
domestic supply shocks accounted for 26 percent of inflation variation and, in
EMDEs, for more than any other type of domestic shock. Domestic demand
and monetary policy shocks explained about 15 percent, each, of domestic
inflation variation.
Fourth, the contribution of global shocks to domestic inflation variation tended

to be higher in EMDEs without inflation targeting regimes, with more open
capital accounts, with greater trade openness, and with global value chain
participation.
Policy makers need to build resilience to global shocks, since their importance as
a source of domestic inflation variation has grown over time. This is particularly
relevant for policy makers in small, open economies with deep or rapidly
growing integration into global trade and financial networks and supply chains.
A menu of policy options is available to offset the impact of global shocks in
EMDEs. These include active use of countercyclical policies as well as
strengthening institutions, including through greater central bank
independence. In addition, ample fiscal space and a sound long-term framework
for fiscal sustainability can ensure that fiscal policy can support macroeconomic
stabilization.
Future research could examine more formally the role of country characteristics.
This could be done in a regression framework or by conditioning impulse
responses on country characteristics. In addition, changes in the role of global
and domestic shocks in domestic and global inflation could be examined in
greater detail, for example, by allowing for time-varying coefficients or dynamic
factor loadings.
ANNEX 3.1 Literature review: Drivers of

domestic inflation
The evidence for a major contribution of global shocks to domestic consumer price
inflation is mixed but strongest for global commodity price shocks, particularly in the
case of the oil price collapse of 2014-16. The role of global factors, whether global
demand and supply shocks or global commodity price shocks, appears to be stronger in
countries that are more open to trade, more integrated into global supply chains, and
with a greater share of traded goods in the consumer price index basket. The
literature on the impact of domestic shocks in emerging market and developing
economies (EMDEs) suggests that they explain a substantial portion of the variance of
inflation. Domestic supply shocks are at least as important as shocks to demand, but
the role of demand shocks has been growing. In EMDEs, the transmission of
monetary shocks to inflation is hampered by underdeveloped financial markets as well
as by institutional weaknesses.
A large literature has documented the growing role of global factors in domestic
inflation. Although strong comovement of inflation among countries is a well-
established finding, explanations vary: spillovers from global demand, common
supply or commodity price shocks, and trade and financial linkages (Chapter 2).
Meanwhile, empirical studies have also typically found an important, albeit
diminishing, role of domestic shocks in domestic inflation. Domestic monetary
policy is, over the long run, the determining factor for domestic inflation, a
principle recognized in the numerical inflation targets set for central banks in
many countries. That said, nonmonetary factors, on the demand and supply
sides of the economy, and movements in foreign exchange rates can drive short-
and medium-term movements in inflation. With increasing globalization,
external factors may play a more prominent role (Table A.3.1.1). Against this
background, this annex presents a brief survey of the literature to address the
• How much do global shocks contribute to domestic inflation, and how does
the contribution differ by country characteristics?
• How much have oil price shocks contributed to post-crisis inflation?
• What is the relative importance of global and domestic shocks in inflation
dynamics?
Role of global shocks in domestic inflation
Empirical studies have documented the role of global shocks in the dynamics of
domestic inflation in individual countries using two approaches: a Phillips curve
framework and structural vector autoregression (SVAR) or factor-augmented
vector autoregression (FAVAR) models. Phillips curve-based evidence on the
role of global factors has been mixed, possibly reflecting measurement error in
global output gap estimates. In contrast, vector autoregression (VAR)–based
studies have typically found an important contribution of global shocks,
especially commodity price shocks, to inflation.1
Phillips curve framework. A group of studies has tested the hypothesis that
inflation is driven by global slack, in addition to, or instead of, domestic slack.
The results have been mixed.
• Global output gap matters. Borio and Filardo (2007), in a sample of 15
Organisation for Economic Co-operation and Development (OECD)
economies during 1985-2005, find that global inflation and the global
output gap add explanatory power to conventional Phillips curve models of
domestic inflation.2 Filardo and Lombardi (2014) also find an important
role for global demand shocks, in part transmitted through global
commodity price shocks, in inflation in Asian countries. Altansukh et al.
(2017) test for structural breaks in the correlation between the components
(energy, food, and core) of domestic and trade-weighted foreign inflation in
13 OECD countries during 1970-2013. They find that the short-run
sensitivity of headline inflation to foreign energy inflation has increased
significantly, but that the synchronization of movements in core inflation
has not.
• Global output gap does not matter. In contrast, Ihrig et al. (2010) find that
in estimates of the Phillips curve for a subset of 11 OECD countries during
1977-2005, the sensitivity of inflation to the global output gap was
generally insignificant and often of the wrong sign, and that the sensitivity
of inflation to domestic output gaps remained unchanged over time.
Similarly, in a broader sample of 24 OECD economies during 1980-2007,
Eickmeier and Pijnenburg (2013) find a statistically significant impact on
domestic inflation, only for global unit labor cost growth—not global
output gaps. Mikolajun and Lodge (2016) estimate Phillips curves
augmented by global output gaps, global inflation, and global commodity
prices for 19 OECD countries and find little support for a significant role of
global economic slack in domestic inflation.3 Kabukçuoğlu and Martínez-
1 In a rare study using micro data, Andrade and Zachariadis (2016) find that individual prices adjust to
global shocks more slowly than to domestic shocks.

2 Some studies have examined the role of other external shocks, such as U.S. monetary policy shocks.
Using an SVAR framework, Maćkowiak (2007) analyzes the importance of external shocks in the
determination of output and inflation in eight Asian countries between 1986 and 2000 and finds that
external shocks explained nearly half the variation in inflation.
3 Moreover, the results suggest that the importance of global inflation in forecasting domestic inflation
has its roots solely in its ability to capture slow-moving trends in inflation rates. In the Phillips curve
context, the same role is performed by domestic forward-looking inflation expectations.
García (2018) model inflation expectations for 14 OECD countries in a

Phillips curve framework that is augmented by the global output gap and
global inflation. Again, they find no robustly statistically significant role for
global output gaps—which they attribute to measurement error—although
they find a significant role for global inflation.
Vector autoregression models. VAR models have more successfully
demonstrated a significant role for global developments in driving domestic
inflation. Ciccarelli and Mojon (2010) attribute a third of inflation variation to
global factors in 22 OECD countries during 1960-2008. Neely and Rapach
(2011) attribute more than half of the inflation variation in 64 countries during
1951-2009 to international (global and regional) factors. Mumtaz, Simonelli,
and Surico (2011) find a growing share of inflation variation contributed by
global factors in 36 mostly advanced economies since 1960. Commodity price
shocks are also an important driver of inflation. Using a structural dynamic
factor model for Canada, Charnavoki and Dolado (2014) find that global
demand, supply, and commodity price shocks played an important role in
Canadian inflation during 1975-2010. Furceri, Loungani, and Zdzienicka
(2018), in a sample of 34 advanced economies during the 2000s, find that a
hypothetical 10 percent increase in global food inflation would have raised
domestic inflation by about 0.5 percentage point after a year, but the estimated
impact declined over time and became less persistent.
Role of global oil price shocks in post-crisis domestic inflation
Euro Area evidence. Using a Bayesian VAR model, ECB (2017) documents a
particularly pronounced contribution of global demand and oil supply shocks to
Euro Area inflation in 2008-09 and 2014-16. The authors argue that
commodity price movements were the main driver of the global common factor
in inflation. However, also in a Bayesian VAR model for the Euro Area, Conti,
Neri, and Nobili (2015) find that inflation during 2013-14 was depressed as
much by monetary and demand shocks as by oil price movements.
Evidence from the 2014-16 oil price plunge. A recent group of studies focuses
on the 70 percent drop in the price of oil from the peak in July 2014 to
the trough in January 2016. World Bank (2015, 2018) and Sussman and Zohar
(2015) attribute the oil price decline largely to a positive oil supply shock, as
the Organization of the Petroleum Exporting Countries decided to protect its
global oil market share amid growing U.S. shale oil production. Weak demand
played a more prominent role in the subsequent decline in late 2015-16.
Berganza, Boralla, and del Río (2016) document that extremely low inflation
since the Great Recession has in part reflected the sharp decline in oil prices
during 2014-16.
Role of country characteristics
Carney (2015) voices broader concerns among central banks that increased
competition from overseas and global financial market integration may have
changed the relationship between inflation and domestic economic conditions.
Several studies, discussed here, have established empirically that global factors
play a greater role in driving domestic inflation in countries with greater trade
and global value chain integration, and with a greater share of goods in the
consumer price index (CPI) whose prices are highly correlated with global
shocks.
Trade integration. Auer, Borio, and Filardo (2017) estimate a Phillips curve
model for producer price inflation, augmented by global slack, for 18 OECD
countries for 1982-2006. The significantly positive coefficient estimate of the
interaction between global slack and global value chain participation indicates
that global value chains form an important transmission channel from global
slack to domestic inflation. In time-varying-coefficient VAR models, Bianchi
and Civelli (2015) find that the impulse responses of inflation to global slack are
larger in more trade-open economies and in those with higher business cycle
integration. Theoretical considerations developed by Martínez-Garcia and
Wynne (2010) suggest that inflation will generally be less responsive to domestic
slack the more open the economy is to international trade.
Exposure to food and energy price shocks. Furceri, Loungani, and Zdzienicka
(2018) provide evidence that the global food price shocks of the 2000s had a
larger impact on domestic inflation in emerging market and developing
economies (EMDEs) than in advanced economies. They attribute this to the
greater share of food in the consumption baskets of EMDEs and the weaker
anchoring of inflation expectations in EMDEs than in advanced economies.
Berganza, Boralla, and del Río (2016) find that the post-crisis oil price drop
depressed global inflation between 2014 and 2016. The direct effects of falling
oil prices were greater in countries with larger shares of oil in the CPI and higher
energy taxation (usually in the form of per unit tax rates), as well as in countries
where currency depreciations were associated with the oil price drop.
Role of domestic shocks in domestic inflation
In the past two decades, empirical studies have typically found an important,
albeit diminishing, role of domestic shocks in domestic inflation. A summary of
selected empirical studies on the importance of domestic shocks in inflation
dynamics is provided in Table A.3.1.1.
Evidence on advanced economies. Several studies have offered evidence that
domestic shocks play a key role in domestic inflation dynamics. Globan,
Arčabić, and Sorić (2015) find, for non-Euro Area new European Union
member states, that short-run inflation dynamics could be explained mainly by

domestic factors, even if foreign shocks became the major driver of inflation in
the medium term. Bobeica and Jarociński (2017), using a medium-scale,
reduced-form VAR, document that domestic shocks can explain the “missing
disinflation” and “missing inflation” episodes in the United States and the Euro
Area in the 2010s. However, Pain, Koske, and Sollie (2006) find, for OECD
countries since the mid-1990s, that the sensitivity of inflation to domestic
economic conditions has declined.
Evidence on EMDEs. Studies on EMDEs have similarly found that domestic

shocks play a predominant role in domestic inflation dynamics, even if the role
of global shocks may have grown. For European Union countries, the evidence
is mixed, with Vašíček (2011) arguing that global shocks were the main drivers
of inflation in the Czech Republic, Hungary, Poland, and the Slovak Republic
during 1998-2007 but Halka and Kotlowski (2017) finding that domestic
shocks played an important role in inflation dynamics in the Czech Republic,
Poland, and Sweden, including by transmitting global demand shocks through
the domestic output gap. For Asia, Osorio and Unsal (2013) estimate that
domestic shocks explain around 70 percent of total variation in domestic
inflation in 33 countries.
Role of monetary policy in domestic inflation
There is an extensive literature on the transmission of monetary policy to the

domestic economy. One of the challenges this research has had to address is the
simultaneity between monetary policy and economic development: monetary
policy responds to the economy, as well as vice versa (Leeper, Sims, and Zha
1996; Gertler and Karadi 2015). Most studies of the transmission of monetary
policy to the economy have focused on advanced economies. Using structural
model frameworks, many of these studies have shown that monetary policy
explains a substantial part of the variation in domestic inflation, with statistical
significance.4 The literature has evolved by developing more advanced empirical
frameworks that purport to address the problem of simultaneity. Surveys of this
work are provided by Boivin, Kiley, and Mishkin (2010); Benati and Goodhart
(2010); and Bhattarai and Neely (2016). Ramey (2016) and Stock and Watson
(2017) discuss the evolution of estimation strategies.
4 For instance, Canova and De Nicolo (2002) show that monetary disturbances explain large portions
of output and inflation fluctuations in the G7 economies. The explanatory power of monetary
disturbances for output variability in Canada, Germany, Italy, and the United Kingdom is found to
exceed 22 percent; for inflation variability in Italy, Japan, the United Kingdom, and the United States, it
is found to exceed 54 percent.
Evidence on EMDEs. The evidence on the transmission of monetary policy to

macroeconomic conditions is less clear for EMDEs than for advanced
economies. A group of earlier studies focused on challenges that EMDEs face in
the implementation of monetary policy and specific channels of monetary policy
transmission.5 These challenges include higher default risk, underdeveloped
financial markets, and weaker institutions.6 Although the interest rate and asset
price channels of monetary policy transmission are limited, and sometimes
insignificant (Mohanty and Turner 2008; Vonnák 2008), some studies have
found that the exchange rate channel plays a significant role in EMDEs (Neaime
2008; Bhattacharya, Patnaik, and Shah 2011). In low-income countries, because
of undeveloped financial markets, monetary policy transmission relies heavily on
the bank lending channel. The evidence on its effectiveness is mixed .7
Role of domestic demand and supply shocks in domestic inflation
Several studies have examined nonmonetary macroeconomic shocks as drivers of
domestic inflation. Domestic demand shocks include, for example,
unanticipated changes in government spending, while domestic supply shocks
include unanticipated changes in the availability of goods or services resulting
from such factors as severe weather events, labor strikes, and changes in
productivity. The effects of such shocks on prices may be transitory or
permanent, depending partly on the nature of the shock and partly on the
monetary policy regime and anchoring of inflation expectations.
Evidence on advanced economies. Melolinna (2015) uses a FAVAR framework
to study inflation dynamics in the Euro Area, the United Kingdom, and the
United States. The results suggest that headline inflation in the three economies
reacted in a similar fashion to macroeconomic shocks over the previous four
decades, with demand shocks having the most persistent effects. Gambetti,
Pappa, and Canova (2005) examine the dynamics of U.S. output and inflation
using a structural time-varying coefficient VAR. They find that a combination of
technology, demand, and monetary shocks explained variations in the
persistence and volatility of inflation. These and other studies have found that,
along with monetary policy shocks, real macroeconomic shocks, both demand
and supply, help to explain inflation dynamics in advanced economies.
Evidence on EMDEs. Several empirical studies have analyzed the effects of
supply and demand shocks on inflation in EMDEs. A broad finding is that
5 Hammond, Kanbur, and Prasad (2009); Mishra, Montiel, and Spilimbergo (2012).
6 Frankel (2011); Agenor and Aynaoui (2010); Wu, Luca, and Jeon (2011).
7 Mishra, Montiel, and Sengupta (2016); Mishra and Montiel (2012); Disyatat and Vongsinsirikul
(2003); Golenelli and Rovelli (2005); Catao and Pagan (2010); Singh and Kalirajan (2007); Aleem
(2010).
supply shocks, which tend to be associated with changes in relative prices, have
to be more important than shifts in demand, but that the role of demand shifts
has grown. Mohanty and Klau (2001), in a study of 14 EMDEs during the
1980s and 1990s, find significant effects from supply shocks, especially from
those affecting food prices. Several studies focus on regional groups of EMDEs:
• Asia. Osorio and Unsal (2013), using a set of global VAR and SVAR
models, study the drivers of inflation in 33 Asian countries during 1986-
2010. They find that supply shocks explained around 45 percent of total
variation in cyclical inflation, and monetary shocks around 35 percent, but
that the role of demand factors had increased since 2000.8 Dua and Gaur
(2009) investigate the determinants of inflation in the framework of an
open-economy Phillips curve model for eight Asian countries during 1990-
2005. They find that agriculture-related supply shocks were a significant
determinant of inflation for EMDEs but not for advanced economies.
• Sub-Saharan Africa. Nguyen et al. (2017) analyze inflation dynamics in
Sub-Saharan African countries, using a global VAR model. They find that
in the previous 25 years, the main drivers of inflation were shocks to
domestic supply, the exchange rate, and monetary variables, but, in the
most recent decade, domestic demand pressures and global shocks played
larger roles than previously. Similarly, using the SVAR framework of
Blanchard and Quah (1989), Ahmad and Pentecost (2012) study inflation
dynamics in 22 African countries. They find that the most important source
of inflation was demand shocks, which accounted for between 50 and 90
percent of inflation variation in all countries.
• Middle East. Hasan and Alogeel (2008) find, for Saudi Arabia and Kuwait
between 1964 and 2007, that, in the long run, inflation in trading partners
was the main factor affecting inflation, with a smaller contribution from
exchange rate pass-through. The estimated impacts of domestic demand and
monetary shocks were confined to the short run. Kandil and Morsy (2010)
study the determinants of inflation in Gulf Cooperation Council countries
during 2003-08, using a model that includes domestic and external factors.
They find that binding capacity constraints (supply side) and government
spending (demand side) helped to explain short-term movements in
inflation.
8 However, the supply and demand shocks include external factors, for example, commodity price
shocks and inflation spillovers from other Asian countries. The contribution to inflation of domestic
supply shocks varied from one country to another, between zero and 40 percent.
TABLE A.3.1.1 Literature review: Drivers of inflation—Panel A. Studies on advanced economies 182
Shocks
Sample Sample
Paper Methodology DD DS MP ER Main results
countries period
Inflation targeting and monetary policy shocks explain 76
Amisano and Tristani 1970:1-
Euro Area DSGE √ √ and 9 percent of inflation variation, respectively. Tax and
CHAPTER 3
(2007) 2004:4
technology shocks are less important.
Domestic shocks are more important in the missing
Bobeica and 1990:1-
Euro Area and U.S. BVAR √ √ √ √ inflation episode, whereas global shocks are more
Jarociński (2017) 2014:4
important in the missing disinflation episode.
Canova and De Monetary shocks are the dominant source of output and
G7 1973-95 VAR √
Nicolò (2002) inflation fluctuations in three of the seven countries.
Foreign shocks (oil supply and global demand) and
Conti, Neri, and Nobili 1995:1-
Euro Area BVAR √ √ aggregate demand are the main drivers of inflation;
(2017) 2015:3
monetary policy is less important.
Technology, demand, and monetary shocks explain the
Gambetti, Pappa, and 1970- variation in inflation, with technology contributing 25
US SVAR √ √ √
Canova (2005) 2002 percent, demand 17 percent, and monetary policy 14
percent, on average.
Bulgaria, Croatia, Czech
Foreign shocks are the major factor in explaining
Globan, Arčabić, and Republic, Hungary, Latvia,
2001-13 SVAR √ √ inflation dynamics in the medium run; short-run inflation
Sorić (2015) Lithuania, Poland, and
dynamics are mainly influenced by domestic shocks.
Romania
1975M1-
Melolinna (2015) Euro Area, UK, U.S. FAVAR √ √ √ Demand shocks are more persistent drivers of inflation.
2012M12
Supply shocks are the key drivers of inflation, with
Mumtaz, Zabczyk, 1964:1-
UK FAVAR √ √ √ monetary policy shocks having a small initial impact that
and Ellis (2011) 2005:1
slowly increases over time.
The sensitivity of inflation to domestic economic
Pain, Koske, and 1985- conditions has declined, whereas the sensitivity to
OECD countries VAR √
Sollie (2006) 2005 foreign economic conditions has risen, working through
import prices.
Note: BVAR = Bayesian vector autoregression; DD = domestic demand; DS = domestic supply; DSGE = dynamic stochastic general equilibrium; ER = exchange rate; FAVAR = factor-augmented vector
autoregression; G7 = Group of Seven; MP = monetary policy; OECD = Organisation for Economic Co-operation and Development; SVAR = structural vector autoregression; VAR = vector autoregression.
TABLE A.3.1.1 Literature review: Drivers of inflation—Panel B. Studies on EMDEs
Shocks
Sample Sample
countries period
Demand shocks account for between 50 and 90 percent of
Ahmad and Pentecost 1980-
22 African countries SVAR √ √ inflation variation; domestic supply shocks account for about
(2012) 2015
10 to 40 percent.
Bhattacharya, Patnaik, 1997-
India VAR √ √ Monetary policy impacts inflation through the exchange rate.
and Shah (2009) 2009
Japan; Hong Kong
SAR, China; Korea, Open The output gap is important in explaining inflation in almost all
1990s-
Dua and Gaur (2010) Rep.; Singapore; economy √ √ √ the countries. In developing countries, agricultural supply
2005
Philippines; Thailand; Phillips curve shocks are important but not so in advanced economies.
China; and India
Domestic shocks are important in inflation dynamics with
Halka and Kotlowski Czech Republic, 2000:1-
SVAR √ √ √ transmission via the domestic output gap and exchange rate
(2017) Poland, and Sweden 2014:2
channel.
In the long run, inflation in trading partners is the main driving
factor of inflation, with significant but lower contribution from

Hasan and Alogeel Saudi Arabia and 1966-
ECM √ √ exchange rate pass-through. Demand shocks and money
(2008) Kuwait 2007
supply shocks are important in the short run, but tend to
dissipate quickly.
China; India; Indonesia;
Jongwanich and Park Korea, Rep.; Malaysia; 1996:1- Inflation is largely due to excess aggregate demand and
SVAR √ √
(2008) Philippines; Singapore; 2008:1 inflation expectations rather than external price shocks.
Thailand; and Vietnam
China; Hong Kong SAR,
Jongwanich, China; India; Indonesia; Cost-push factors such as oil and food prices are more
2000:1-
Wongcharoen, and Park Korea, Rep; Malaysia; SVAR √ √ important in explaining PPI than CPI. For CPI, demand-pull
2015:2
(2016) Philippines; Singapore; factors still explain much of the inflation.
Thailand; and Vietnam
CHAPTER 3
Note: CPI = consumer price index; DD = domestic demand; DS = domestic supply; ECM = error correction model; ER = exchange rate; MP = monetary policy; PPI = producer price index; SVAR =
structural vector autoregression; VAR = vector autoregression.
183
TABLE A.3.1.1 Literature review: Drivers of inflation—Panel B. Studies on EMDEs (continued) 184
Shocks
Sample Sample
countries Period
Bahrain, Kuwait, Oman,
Inflation in major trading partners is an important foreign factor.
Kandil and Morsy Qatar, Saudi Arabia,
1970-2007 VECM √ √ In addition, oil revenues have reinforced inflationary pressures
CHAPTER 3
(2010) and United Arab

through growth of credit and aggregate spending.
Emirates
Supply shocks explain 48 percent of variation in inflation, while
Khan and Hanif
Pakistan 1992-2011 SVAR √ √ √ the share of real demand shocks was around 10 percent and
(2012)
the remaining 42 percent attributed to nominal shocks.
The output gap is a significant determinant of inflation. Supply
Open
Mohanty and Klau 1981:1- side factors and import prices (especially food prices, via the
14 EMDEs economy √ √ √ √
(2001) 1999:4 exchange rate channel) are also important, but money supply
Phillips curve
is less relevant.
Egypt, Arab Rep.;
In Egypt and Turkey, the exchange rate played a dominant role
Jordan; Turkey; 1990s-
Neaime (2008) VAR √ √ in the transmission mechanism of monetary policy; for Jordan,
Lebanon; Morocco; and 2000s
Lebanon, Morocco, and Tunisia, it was the interest rate.
Tunisia
Main drivers of inflation have been domestic supply shocks and

33 Sub-Saharan African shocks to exchange rate and monetary variables. However, in
Nguyen et al. (2017) 1988-2013 VAR √ √ √ √
countries recent years, domestic demand and global shocks have played
a larger role in driving inflation.
Monetary and supply shocks are the main drivers of inflation,

Osorio and Unsal
33 Asian countries 1986-2010 GVAR, SVAR √ √ √ √ but more recently demand shocks are increasing in
(2013)
importance.
1996:1- Global shocks are more important than domestic demand and
Porter (2010) China BVAR √ √ √
2010:1 monetary conditions.
Czech Republic, New
1998:1-
Vašíček (2011) Hungary, Poland, and Keynesian √ √ √ Inflation seems to be driven by external factors.
2007:3
Slovak Republic Phillips curve
Note: BVAR = Bayesian vector autoregression; DD = domestic demand; DS = domestic supply; EMDEs = emerging market and developing economies; ER = exchange rate; GVAR = global vector
autoregression; MP = monetary policy; SVAR = structural vector autoregression; VAR = vector autoregression; VECM = vector error correction model.
ANNEX 3.2 Event studies

Global business cycles and oil price swings. The chapter conducts an event
study of inflation around peaks of global expansionary periods and troughs of
global recessions, and oil price plunges and spikes. It uses quarterly per capita
gross domestic product and the algorithm in Harding and Pagan (2002) to iden-
tify turning points of global business cycles. The exercise finds four peaks of
global expansions (1973:4, 1981:3, 1990:3, and 2008:2) and four troughs of
global recessions (1975:1, 1982:4, 1991:1, and 2009:1). In addition to these
four global recessions, Kose and Terrones (2015) identify two global slowdowns
(1998 and 2000-01) since 1960. World Bank (2015) identifies oil price plunges
as episodes of 30 percent or more declines in oil prices over a six-month period,
of which there have been six since 1970 (1985-86, 1990-91, 2001, 1997-98,
2007-09, and 2014-16). Oil price spikes are similarly identified and occurred in
1973-74, 1979, 1987-91,1999-2002, and 2004-08.
Disinflation episodes. Country-specific disinflation episodes are defined, using a

variation of Ball (1994), as quarters in which the nine-quarter centered moving
average of headline consumer price index inflation (quarter-on-quarter, seasonal-
ly adjusted) declines by at least 1 percentage point from the peak to the trough.
A trough is the quarter in which trend inflation is lower than in the previous
four quarters and following four quarters. A peak is defined as the quarter in
which trend inflation is above the previous four quarters and following four
quarters. This yields 190 disinflation episodes and 179 inflation episodes in 34
advanced economies, and 719 disinflation episodes and 729 inflation episodes in
134 EMDEs during 1970-2017:3.

Global block
This chapter employs a factor-augmented vector autoregression (FAVAR)

model. In the first step, a global block is estimated in isolation to examine the
roles of different types of global shocks in driving global inflation. In the second
step, the global block is combined with a country-specific block to compare the
roles of global and domestic shocks in driving domestic inflation.
The global block includes three variables: global inflation, global output growth,
and oil price growth (for precise variable definitions, see below). All variables are
detrended using a 60-quarter centered moving average. Global output growth
and global inflation correspond to the global output growth and global inflation
factors estimated separately using the following dynamic factor models:1
Y,i
Yti = βglobal ƒ tY, global + etY,i
π, i
π ti = βglobal ƒt π, global + eπt ,i
where πti and yt are inflation and output growth in country i in quarter t,
respectively, while ƒt π,global and ƒ tY,global are the global common factors for
inflation and output growth in quarter t, respectively.2
In its structural form, the FAVAR model is represented by:

L
BoZt = α + ∑i=1 Bi Zt-1 + εt
where εt is a vector of orthogonal structural innovations, and Zt consists of

global inflation (ƒtπ, global ), global output growth (ƒty, global ), and oil price growth
(∆op). The vector εt consists of a shock to the global supply of goods and
services (“global supply shock”), a shock to the global demand for goods and
services (“global demand shock”), and a shock to oil prices (“oil price shock”).
The chapter follows the methodology in Charnavoki and Dolado (2014) in

using sign restrictions to identify global demand, global supply, and oil price
1 The main assumptions in the estimation of the global factors follow those in Kose, Otrok, and
Whiteman (2008) and Kose, Otrok, and Prasad (2012).

2 The model is specified in terms of growth, not levels, since the variable of interest (inflation) is itself a
growth rate.
B0−1
t ut = B0−1 t
utY , global   + − +   tGlobalDemand 

 OilPrice     OilPrice 
ut  =  + + +   t 
u  , global   + + −   GlobalSupply 
 t    t 
− + 0 0 0 0   t
utY , global   GlobalDemand 
 OilPrice   + 
 + + + 0 0 0 0   t
OilPrice
ut 
u  , global     GlobalSupply 
 t  + + − 0 0 0 0   t 
utY, domestic  = *   DomesticDemand 
* * + + − *  t
  ,domestic    
ut  * * * + − − *   tDomesticSupply 
 InterestRate   * 
* * * * + *   MonetaryPolicy 
ut    t 
u ExchangeRate   * * * * * + +   ExchangeRate 
 t   t 
policy shock increases short-term interest rates (or policy rates) by 0.27
percentage point. A positive one-standard-deviation exchange rate shock
represents a 15 percentage point increase (appreciation) in nominal effective
exchange rate appreciation.
The results for the roles of global and domestic shocks in explaining the
variation in domestic inflation are presented as median point estimates across
countries.4 Interquartile ranges indicate the range from the 25th to the 75th
quartile of country-specific estimates (for example, Forbes, Hjortsoe, and
Nenova 2017).
Bayesian estimation
The system is estimated on a country-by-country basis. The Bayesian estimation
searches for 1,000 successful draws of at least 2,000 iterations with 1,000 burn-
ins. The results shown in the chapter are based on the median of these 1,000
successful draws and 68 percent confidence intervals at the country level,
although alternative presentation methodologies (for example, the median target,
as in Fry and Pagan [2011]) are considered as a robustness check. In the
Bayesian estimation, the Minnesota priors proposed by Litterman (1986) are
used; since the Minnesota prior assumes that the variance-covariance matrix of
residuals is known, the entire variance-covariance matrix of the variance
autoregression is estimated by ordinary least squares. For the estimation, the
identification strategy through the algorithm introduced by Arias, Rubio-
Ramirez, and Waggoner (2014) is used, where the standard Cholesky
decomposition is employed with an additional orthogonalization step that is
necessary to produce a posterior draw from the correct distribution for structural
vector autoregression coefficients.
Database
The sample includes 29 advanced economies and 26 emerging market and
developing economies (EMDEs) with at least 10 years (40 quarters) of
continuous data for the variables in the domestic block, but the sample period
differs across countries (Table A.3.3.1). Long-term components of quarterly
growth rates are proxied by 15-year moving averages, benchmarking Stock and
Watson (2012).5 The following variables are used as inputs in the FAVAR
estimation:
4 Focusing on cross-country medians mitigates concerns that, for the United States and China, the
domestic block might affect the global block contemporaneously.

5 Unit-root tests of 55 quarterly inflation rates indicate that most of the country-specific inflation rates
are stationary or trend-stationary at the 5 percent significance level. Based on these results, long-term
trends in inflation rates are eliminated. As in Chapter 2, the results are qualitatively robust to different
detrending methods (for example, the Hodrick-Prescott or Butterworth filters).
• Global output growth is the global common factor of quarter-on-quarter,

seasonally adjusted real gross domestic product (GDP) growth in a sample
of 29 advanced economies and EMDEs for 1970:1-2017:4.
• Global inflation is defined as the global common factor of quarter-on-
quarter headline consumer price index (CPI) inflation (seasonally adjusted)
in a sample of 47 advanced economies and EMDEs. For robustness, the
estimation is repeated using core inflation and producer price index
inflation, similarly defined.
• Oil price growth is the quarter-on-quarter growth rate of nominal oil prices
(average of Dubai, West Texas Intermediate, and Brent).
• Domestic inflation is quarter-on-quarter, seasonally adjusted headline CPI
inflation.
• Domestic output growth is quarter-on-quarter, seasonally adjusted real
GDP growth.
• Domestic interest rates are quarter-on-quarter differences in three-month
Treasury bill rates or monetary policy rates.
• Nominal effective appreciation is quarter-on-quarter appreciation in trade-
weighted nominal exchange rates against 52 currencies, as provided by the
Bank for International Settlements.
Robustness exercises
Since the FAVAR estimation in this chapter rests on various assumptions about
the relationships among endogenous variables, several robustness checks on the
assumptions are performed. The results presented in this chapter are robust to
the following changes:
• Alternative measures of global inflation and global output in the estimation
of the global block: (i) global inflation and output factors estimated with an
identical group of 25 countries and (ii) median GDP growth and inflation
rates among countries.
• Alternative measures of oil prices in the global block: real oil prices and
nominal energy prices.
• Use of averages, instead of medians, in reporting all country-specific results
on the contribution of global and domestic shocks to domestic inflation
(Table A.3.3.2).
• An alternative number of periods (that is, two-quarters periods) in imposing
sign restrictions in identifying country-specific structural shocks.
• Alternative sign restrictions: positive domestic demand shocks lead to

contemporaneous increases in country-specific, short-term interest rates (or
policy rates).
• Alternative presentations of 1,000 successful draws following Fry and Pagan
(2011): instead of presenting the median across 1,000 successful draws, use
of the draw that is closest to the median across 1,000 successful draws (that
is, the median target). The same strategy has been applied to calculate the
corresponding 68 percent confidence sets, again by following Fry and Pagan
(2011).
• Country-specific FAVAR estimation results for 2001-17 instead of full-
sample results.
TABLE A.3.3.1 List of countries and sample periods

Country sample periods
Country Sample period Country Sample period
Australia 1970:2 - 2017:4 India 1993:3 - 2017:4
Austria 1990:1 - 2017:4 Israel 1985:3 - 2017:4
Azerbaijan 2005:3 - 2017:4 Italy 1979:2 - 2017:4
Belgium 1970:2 - 2017:4 Jordan 1999:3 - 2017:4
Bulgaria 1994:4 - 2017:4 Japan 1989:3 - 2017:4
Brazil 1998:3 - 2017:4 Korea, Rep. 1991:3 - 2017:4
Botswana 1994:4 - 2017:4 Luxembourg 1999:3 - 2017:4
Canada 1970:2 - 2017:4 Mexico 1989:1 - 2017:4
Switzerland 1970:3 - 2017:4 Macedonia, FYR 2008:1 - 2017:4
Chile 1986:3 - 2017:4 Malta 1999:3 - 2017:4
China 1984:4 - 2017:4 Malaysia 2004:4 - 2017:4
Colombia 1994:4 - 2017:4 Morocco 1995:4 - 2017:4
Costa Rica 1997:3 - 2017:4 Netherlands 1982:3 - 2017:4
Czech Republic 1992:4 - 2017:4 Norway 1979:2 - 2017:4
Germany 1970:2 - 2017:4 New Zealand 1974:3 - 2017:4
Denmark 1970:2 - 2017:4 Philippines 1987:3 - 2007:3
Dominican Republic 2004:3 - 2017:3 Poland 1992:1 - 2017:4
Egypt, Arab Rep. 2002:4 - 2017:2 Portugal 1986:2 - 2017:4
Spain 1977:3 - 2017:4 Russian Federation 2000:1 - 2017:4
Finland 1987:3 - 2017:4 Slovak Republic 1996:1 - 2017:4
France 1970:2 - 2017:4 Slovenia 2002:3 - 2017:4
United Kingdom 1970:2 - 2017:4 South Africa 1981:3 - 2017:4
Greece 1994:4 - 2017:4 Sweden 1983:3 - 2017:4
Honduras 2005:4 - 2017:4 Thailand 2000:4 - 2017:4
Hungary 1995:4 - 2017:4 Tunisia 2000:4 - 2017:4
Indonesia 1990:3 - 2017:4 Turkey 2007:1 - 2017:4
Ireland 1984:3 - 2017:4 United States 1970:2 - 2017:4
Iceland 1988:3 - 2017:4
Note: Countries with at least 40 quarters of data have been included.
TABLE A.3.3.2 Contribution of domestic shocks to domestic

inflation
Panel A. Income groups
All countries AEs EMDEs
Median Mean Median Mean Median Mean
Total global shocks 27.7 32.5 33.3 37.0 13.6 19.7
Total domestic shocks 72.3 67.5 66.7 63.0 86.4 80.3
Domestic demand shock 14.5 13.8 12.9 12.2 19.5 19.5
Domestic supply shock 26.0 24.4 25.2 23.8 29.7 25.3
Monetary policy shock 14.4 14.2 13.2 12.5 16.9 16.6
Exchange rate shock 17.3 15.1 15.4 14.5 20.3 18.8
Panel B. Subperiods
1970-85 1986-2000 2001-17
Median Mean Median Mean Median Mean
Total global shocks 23.2 30.3 20.6 26.1 43.2 44.3
Total domestic shocks 76.8 69.7 79.4 73.9 56.8 55.8
Domestic demand shock 15.5 13.5 13.9 13.7 11.3 12.0
Domestic supply shock 28.3 26.2 31.1 27.9 20.8 19.3
Monetary policy shock 14.4 14.0 14.4 14.3 10.6 11.8
Exchange rate shock 18.7 16.1 19.9 18.1 14.2 12.6
Note: The table shows median across countries’ shares of country-specific inflation variance accounted for by domestic
shocks (domestic demand, supply, exchange rates, and interest rates) and global shocks based on country-specific
factor-augmented vector autoregression models estimated for 29 advanced economies and 26 EMDEs for 1970-2017
(panel A) and three subsamples (panel B). AEs = advanced economies; EMDEs = emerging market and developing
economies.
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Vonnák, B. 2008. “The Hungarian Monetary Transmission Mechanism: An Assessment.” In

Transmission Mechanisms for Monetary Policy in Emerging Market Economies, 235-57. Basel:
Bank for International Settlements.
World Bank. 2015. Global Economic Prospects: The Global Economy in Transition.
———. 2018. Global Economic Prospects: Broad-Based Upturn, but for How Long?
Wu, J., A. C. Luca, B. N. Jeon. 2011. “Transmission of Monetary Policy via Domestic and
Foreign Banks in Emerging Economies: Evidence from Bank-Level Data.” Journal of
International Money and Finance 30 (6): 1128-56.
In an interconnected world, fulfilling the Federal Reserve’s
objectives under its dual mandate requires that we pay
close attention to how our own actions affect other
countries and how developments abroad, in turn, spill
back into U.S. economic conditions.
Stanley Fischer (2015)

PART B
INFLATION
Expectations and Pass-Through
CHAPTER 4
Inflation Expectations: Review and Evidence
Inflation expectations play a critical role in enabling the proper formulation of

monetary policy. As such, it is essential for policy makers to have a good
understanding of how inflation expectations are determined. This chapter provides a
comprehensive examination of the determination and evolution of inflation
expectations, with a focus on emerging market and developing economies (EMDEs).
It finds that long-term inflation expectations in EMDEs are not as well anchored as
those in advanced economies, despite notable improvements over the past two decades.
Indeed, in EMDEs, long-term inflation expectations are more sensitive to both
domestic and global inflation shocks. However, EMDEs tend to be more successful in
anchoring inflation expectations in the presence of an inflation targeting regime, high
central bank transparency, strong trade integration, and a low level of public debt.
Introduction
Inflation expectations play a critical role in the effective implementation of
monetary policy. A central bank is more likely to be successful in achieving low
and stable inflation if it can anchor economic agents’ long-term inflation
expectations close to its inflation objective. This is because inflation expectations
are key in the transmission of monetary policy, as they affect current inflation
through their impact on the setting of wages and prices (Bernanke et al. 2001).
Measures of inflation expectations are therefore important yardsticks in assessing
the credibility of a central bank in meeting its inflation objective.
Given the importance of inflation expectations for monetary policy, it is
essential for central banks to have a good understanding of how they are affected
by domestic and global shocks. This is especially critical for central banks in
emerging market and developing economies (EMDEs), since these economies
tend to experience more pronounced business and financial cycles than advanced
economies, and therefore may face greater challenges in anchoring expectations.
There is a rich theoretical and empirical literature on inflation expectations.
Theoretical studies have examined how public and private information is used
by economic agents in formulating inflation expectations. A large body of
empirical work has tested the predictions of theoretical models and assessed how
firmly inflation expectations are anchored, by measuring the sensitivity of
Notes: This chapter was prepared by M. Ayhan Kose, Hideaki Matsuoka, Ugo Panizza, and Dana
Vorisek. Yohei Okawa provided background material for a country case study in Annex 4.5.
expectations to various shocks, such as macroeconomic news shocks or oil or

other price shocks. The literature, however, has mainly focused on advanced
economies.
This chapter presents the first comprehensive analysis of the evolution and
determinants of inflation expectations in EMDEs, with emphasis on three main
questions:
• How does the degree of anchoring of inflation expectations differ between
advanced economies and EMDEs?
• How sensitive are inflation expectations to global and domestic shocks?
• What are the main determinants of the degree of anchoring of inflation
expectations?
The chapter makes several contributions to the literature on inflation
expectations. First, it employs a large and diverse sample of countries (24
advanced economies and 23 EMDEs) for a period of close to three decades.
Second, it analyzes the sensitivity of long-term inflation expectations to global
and domestic inflation shocks using a time-varying parameter regression model.
Third, it examines the determinants of the degree of anchoring of expectations,
using a dynamic panel regression framework. Fourth, it complements the
empirical analysis with case studies that examine the role of inflation targeting in
stabilizing inflation expectations in three EMDEs. In addition, it provides a
summary of the literature with a special focus on empirical studies on the
anchoring of inflation expectations in EMDEs.
The chapter begins by discussing the measurement of inflation expectations,
comparing survey-based and market-based measures. Survey-based measures
have the advantage of being able to incorporate the views of large groups of
economic agents and to canvass different types of agents. Market-based measures
(that is, measures based on comparisons of certain yields in financial markets)
have the advantage of being available at a higher frequency and more extensive
range of horizons than survey-based measures.1
The following section reviews the theoretical and empirical literature on the
formation and anchoring of inflation expectations. Despite a lack of consensus
on the theoretical framework that best captures the behavior of inflation
expectations, the empirical literature has concluded that an inflation targeting
regime helps improve the anchoring of expectations in both advanced economies
and EMDEs.
1 For background on market- and survey-based measures of inflation expectations, see Coibion et al.
(2018) and Grothe and Meyler (2018) for the United States and the Euro Area, and Sousa and Yetman
(2016) for EMDEs.
The next section examines trends in long-term (five-year-ahead) inflation

expectations in advanced economies and EMDEs, from the 1990s to the
present. It then assesses the anchoring of inflation expectations. It finds that
although expectations have become more firmly anchored during the past
decade in both advanced economies and EMDEs, this has been less evident in
EMDEs than in advanced economies. The section also reports that inflation
expectations in EMDEs are more sensitive to both global and domestic shocks
than are inflation expectations in advanced economies, although sensitivity to
global shocks has fallen in both groups of economies and sensitivity to domestic
shocks has fallen in EMDEs.
The subsequent section identifies the main factors that determine the anchoring
of inflation expectations. It presents evidence that inflation expectations are
better anchored in both advanced economies and EMDEs when the central bank
employs an inflation targeting regime and is highly transparent. For EMDEs,
low public debt and a high degree of trade openness are also associated with
better anchoring of expectations, while the use of a fixed exchange rate regime is
associated with weaker anchoring of expectations. These results suggest that the
institutions and framework of monetary policy, the macroeconomic
environment (including fiscal policy), and structural characteristics all matter for
the anchoring of long-term inflation expectations in EMDEs.
The penultimate section presents case studies on the experience of inflation

targeting in Brazil, Chile, and Poland. The conclusions of the case studies are in
line with the empirical findings. In Brazil, less than ideal fiscal conditions and
worsening central bank transparency during part of the inflation targeting period
may have impeded the anchoring of expectations. By contrast, the combination
of high central bank credibility and an effective fiscal framework may have
helped anchor expectations in Chile. In Poland, the transition to a flexible
exchange rate regime concurrent with the adoption of inflation targeting may
have helped to anchor expectations.
The final section concludes with a summary of major findings and a discussion
of future research directions.
Measuring inflation expectations

Robust measurement is key to evaluating inflation expectations, and typically
two sources exist. Survey-based measures are derived from surveys of households,
firms, or professional forecasters, in which respondents are asked about their
expectations for inflation at various horizons. Market-based measures are
calculated from the prices of assets linked to prospective inflation. Each measure
has advantages and drawbacks.
Survey-based measures
Surveys of households and firms. Among advanced economies, commonly

referenced surveys of households’ inflation expectations include the University of
Michigan’s Surveys of Consumers (monthly frequency for the United States),
the European Commission’s consumer survey for the countries of the European
Union (monthly), and the Bank of England’s consumer survey (quarterly) for
the United Kingdom.2 High-frequency surveys of households’ or firms’ inflation
expectations are also conducted by Australia, Canada, the Czech Republic, Italy,
Japan, the Republic of Korea, New Zealand, and Sweden. Among EMDEs,
survey-based measures of households’ or firms’ expectations are produced by
central banks in East Asia (for example, Indonesia, the Philippines, and
Thailand), Europe and Central Asia (for example, Kazakhstan and Turkey), and
India and South Africa.3
Surveys of professional forecasters. The most commonly used survey of

professional forecasters is produced by Consensus Economics, which
incorporates the views of more than 700 professional forecasters in 85 advanced
economies and EMDEs. Consensus Economics publishes short-term
expectations at a monthly frequency and long-term expectations at a semi-
annual or quarterly frequency.4 Other surveys of professional forecasters include
the Survey of Professional Forecasters by the Federal Reserve Bank of
Philadelphia, which provides data on expectations up to 10 years ahead, and the
European Central Bank’s Survey of Professional Forecasters. Central banks in
several other economies (for example, Argentina, Brazil, Iceland, Indonesia,
Israel, Mexico, South Africa, and Turkey) also produce professional survey-based
measures of inflation expectations. Surveys of inflation expectations in EMDEs
typically have smaller samples than those in advanced economies, but the
number of EMDEs included in Consensus Economics’ surveys has increased
over time, from seven in 1990 to 52 in 2018.5
Differences between surveys of households or firms and surveys of professional

forecasters. On average, households’ and firms’ inflation expectations are higher
2 Most survey results are presented as median responses. Discrepancies among respondents can be
informative as a proxy of inflation uncertainty (Mankiw, Reis, and Wolfers 2003; Miles et al. 2017).
3 For the European Union, a data set on inflation expectations has been collected by the European
Commission since 2003. Although it has been used for research purposes, it has not yet been published
(Arioli et al. 2017). Some central banks (for example, those of China, Poland, and Romania) release
survey results showing the percentage of respondents who expect inflation to change.
4 In addition, Germany’s Ifo Institute has provided data on five-year-ahead inflation expectations for
more than 70 countries since the end of 2014.

5 The International Monetary Fund’s World Economic Outlook has the broadest country coverage of
long-term inflation projections (39 advanced economies and 154 EMDEs).

than professional forecasters’ expectations in advanced economies and EMDEs

(Figure 4.1). The volatility of households’ inflation expectations is also larger
than that of professional forecasters’ expectations. Households’ beliefs about past
inflation are found to be a strong predictor of their inflation expectations
(Jonung 1981; Malmendier and Nagel 2016). Households’ inflation
expectations are thus more backward looking than professional forecasters’
expectations.6
Several reasons for these differences have been suggested. First, households’ and
firms’ expectations are subject to “sticky information” and are updated more
slowly than those of professional forecasts (Carroll 2003). Second, household
surveys give the same weight to “informed” and “uninformed” consumers.
Because uninformed consumers likely give excess weight to goods that are
purchased frequently (for example, food) or have highly visible price changes
(for example, gasoline), their assessment of inflation expectations can be biased
upward when the prices of these products increase (Coibion and Gorodnichenko
2015; Coibion, Gorodnichenko, and Kamdar, forthcoming; Sousa and Yetman
2016). Yet, surveys of households and firms also have important advantages
relative to surveys of professional forecasters—for instance, they can be designed
to include a large number of respondents and have the flexibility to canvass
different types of economic agents. For surveys of professional forecasters, bias
may arise from respondents’ reluctance to reveal their expectations about
inflation because they consider the information private (Cunningham,
Desroches, and Santor 2010).
Market-based measures
The most commonly used market-based measure of inflation expectations is the

break-even inflation rate—that is, the difference between yields on comparable
nominal and inflation-indexed bonds. In general, however, this difference
consists of four components: expected inflation, an inflation risk premium, a
liquidity premium, and other factors (Hördahl 2009; Christiansen, Dion, and
Reid 2004). Hence, extracting expected inflation requires the use of strong
assumptions, and any estimate of expected inflation is necessarily imprecise
(Galati, Heemeijer, and Moessner 2011).
Another common market-based measure is the inflation swap rate based on

derivative instruments, which again includes not only inflation expectations, but
6 Kumar et al. (2015) and Kabundi, Schaling, and Some (2015) document that in New Zealand and
South Africa, some firms do not understand the central bank’s objective function. Hence, even if
professional forecasters’ expectations are well anchored by inflation targeting in these countries, the same
is not necessarily true of firms’ inflation expectations. The latter may be more important for actual
inflation, because firms may incorporate expected marginal costs into their product prices.
FIGURE 4.1 Survey-based measures of inflation expectations:

Country evidence
Inflation expectations derived from surveys of households tend to be higher, and their
volatility larger, than inflation expectations derived from surveys of professional forecasters.
This finding holds for both advanced economies and EMDEs where both types of surveys
are conducted.
A. 1-year-ahead inflation expectations, B. 1-year-ahead inflation expectations,

selected advanced economies, average selected EMDEs, average
C. Volatility of 1-year-ahead inflation D. Volatility of 1-year-ahead inflation

expectations, selected advanced economies expectations, selected EMDEs
E. 5-year-ahead inflation expectations, F. 5-year-ahead inflation expectations, South

selected advanced economies, average Africa
Source: Bank of Japan; Bloomberg; Bureau of Economic Research, South Africa; Central Bank of the Philippines;
Consensus Economics; Haver Analytics; International Monetary Fund; Reserve Bank of India; Reserve Bank of New
Zealand; University of Michigan; World Bank.
A.C. The sample period is 2006H1-2018H1.
B.D. The sample period is 2007H2-2018H1.
C.D. Volatility is measured by standard deviation.
E. The sample period is 2009H1-2018H1.
also the inflation risk premium and liquidity premium. A key advantage of the
swap rate is that, unlike for break-even inflation rates, liquidity has a limited
impact on its movements (Grothe and Meyler 2018). Both types of market-
based measures have the advantage of being available at very high frequencies,
which may help policy makers develop an understanding of how inflation
expectations are formed and may be calculated at a wider range of forecast
horizons than is possible using surveys. However, swap markets in EMDEs are
typically insufficiently developed to allow such a measure to be reliably
extracted. Therefore, central banks in several large EMDEs (for example, Brazil,
Chile, Colombia, Mexico, Peru, Poland, the Russian Federation, South Africa,
Thailand, and Turkey) typically derive their market-based measures of inflation
expectations from inflation-indexed government bonds (Sousa and Yetman
2016; De Pooter et al. 2014).
Differences between survey-based and market-based measures. In terms of the

level of inflation expectations, those derived from surveys of professional
forecasters are not systematically higher or lower than market-based measures
(Figure 4.2). However, professional forecasters’ inflation expectations tend to be
close to central bank inflation forecasts, as has been shown for New Zealand and
the United States (Coibion and Gorodnichenko 2015). In addition, the
volatility of professional forecaster-based expectations tends to be lower than
that of market-based expectations. During periods of market stress, break-even
inflation rates can be particularly volatile because “flight-to-liquidity” flows raise
demand for government bonds sharply.7 This could push nominal yields to
extremely low levels and put strong downward pressure on measured break-even
inflation rates (Hördahl 2009). Relative to survey-based measures of inflation
expectations, an advantage of market-based measures is that they cannot be
influenced by poorly crafted surveys.
Expectations measure used in this chapter
Due to the breadth of its country coverage and length of its time coverage, the
main long-term inflation expectations series used in this chapter are the survey-
based, five-year-ahead expectations produced on a semi-annual basis by
Consensus Economics. In the empirical work, the change in long-term inflation
expectations is measured as the difference between five-year-ahead inflation
expectations in the current period and five-year-ahead inflation expectations in
the previous period (that is, six months prior).
7 During periods of market stress, investors may have a strong preference for holding very liquid
securities, such as government bonds. This preference can lead to sharp movements in bond markets (that
is, flight to liquidity), similar to market movements driven by flight to quality.
FIGURE 4.2 Survey-based and market-based measures of inflation

expectations: Country evidence
Across countries, inflation expectations derived from surveys of professional forecasters

are not systematically higher or lower than market-based measures of expectations.
However, the volatility of market-based inflation expectations tends to be higher than that of
survey-based expectations in both advanced economies and EMDEs.
A. 5-year-ahead inflation expectations, B. 5-year-ahead inflation expectations,

selected advanced economies, average selected EMDEs, average
C. Volatility of inflation expectations, selected D. Volatility of inflation expectations, selected

advanced economies EMDEs
Source: Bloomberg; Consensus Economics; International Monetary Fund; World Bank.

A.-D. Market-based inflation expectations are inflation swap rates (five-year, five-year forward) for advanced economies
and break-even inflation rates (five-year-ahead) for EMDEs.
A.C. The sample period is 2007H1-2018H1.
B.D. The sample period is 2012H2-2018H1.
C.D. Volatility is measured by standard deviation.
Literature on inflation expectations

Theories of inflation expectations have mainly focused on how expectations
reflect public and private information. There remain different views on which
conceptual framework is best.8 Empirical studies, most of which have focused on
8 Coibion, Gorodnichenko, and Kamdar (forthcoming) and Mankiw and Reis (2018) survey the
literature on the formation of expectations. Annex 4.1 presents a brief overview of how views on the
linkages between inflation expectations and monetary policy have evolved over time.
advanced economies, concentrate on testing the implications of the theoretical

literature and evaluating the degree of anchoring of expectations.9
The theoretical literature on the determinants of inflation expectations ranges
from models that assume agents have “full-information rational
expectations” (FIRE) to models that allow for constraints on agents’ ability to
process information.10 There is still no consensus on an ideal framework to
describe how inflation expectations are determined (Mankiw and Reis 2018).
With its simple formulation of the relationship between inflation and economic
activity, the New Keynesian model has been used extensively in policy and
academic circles. However, it has also been subject to criticism—in particular,
that it does not take into account the constraints that economic agents typically
face in forming their expectations about inflation. For example, Friedman
(1979) argues that FIRE does not explain how “economic agents derive the
knowledge which they then use to formulate expectations.”
FIRE models have also been criticized for their inability to explain the
persistence of inflation that is usually found in the data. These criticisms have
led to two alternate approaches in modeling the role of information in the
formation of inflation expectations: the sticky-information model and the noisy-
information model. In the sticky-information model, forecasts are updated
slowly because acquiring information is costly (Mankiw and Reis 2002). The
assumption of sticky-information flow can be rationalized in terms of an
“epidemic” model of news diffusion (Carroll 2003).11
Models of noisy information and rational inattention instead assume that
economic agents continuously update their information but receive imperfect,
“noisy” signals or do not pay attention to all news (Woodford 2002; Sims 2003;
Maćkowiak and Wiederholt 2009; Coibion, Gorodnichenko, and Kamdar
2018). Departures from the full-information assumption can also be rationalized
in the context of “learning” models, which assume that agents need to use
statistical methods to learn about the central bank’s objective function and the
overall structure of the economy (Evans and Honkapohja 2009).12
9 Annex 4.2 lists a number of empirical studies on the evolution, determinants, and anchoring of
inflation expectations in advanced economies and EMDEs.

10 Agents with FIRE are assumed to understand perfectly the structure and functioning of the economy
and the policy makers’ objective function (Bernanke 2007).

11 In the “epidemic” model, households’ inflation forecasts are affected by media and professional
inflation forecasts.
12 Coibion, Gorodnichenko, and Kamdar (forthcoming) discuss models featuring other departures
from FIRE, including bounded rationality and adaptive learning models. Models with bounded
rationality assume that agents build a simplified model of the world, paying attention to only some of the
relevant variables. Adaptive learning models assume that agents behave like econometricians, using the
available information at the time of the forecast and following a specific updating mechanism.
On the operational side, the assumption that a fraction of firms is not fully
rational and instead sets prices using a rule of thumb that depends on past
inflation led to the development of the hybrid New Keynesian Phillips curve. In
this specification, current inflation depends on both expected and lagged
inflation (Fuhrer and Moore 1995; Galí and Gertler 1999). In particular, the
model takes into account backward- and forward-looking inflation expectations
(that is, inflation expectations are determined by past inflation and expectations
about those variables viewed as determining actual inflation). Some
specifications of the model also control for foreign inflation (for example, IMF
2016).
In addition to fitting the data better, the hybrid New Keynesian Phillips curve is
well suited to the reality of constantly evolving economic structures. The
standard New Keynesian Phillips curve implies that long-run inflation
expectations do not respond to news because the public knows the long-run
equilibrium. The hybrid curve is consistent with an environment in which the
structure of the economy is not perfectly understood by policy makers or the
public. The hybrid curve can also fit environments in which the central bank’s
objective function is not completely known by economic agents or it is not
optimal for all agents to update their information constantly (Bernanke 2007;
Kumar et al. 2015).13
Learning models and models of noisy information also allow for a more
sophisticated formalization of the drivers of expectation anchoring. For example,
these types of models imply that long-run expectations will be well anchored—
and thus will not respond to news—if private agents are confident about their
estimates of future inflation. In an inflation targeting framework, the anchoring
of expectations is therefore related to the public’s confidence that the central
bank is willing and able to reach the target.14
Empirical evidence
Formation of expectations. One strand of studies examines the empirical

relevance of the sticky-information and noisy-information models. Mean
inflation forecasts from professional forecasters, consumers, firms, and central
bankers have all been found to respond to macroeconomic shocks with a delay
(Coibion and Gorodnichenko 2012). Because mean forecasts adjust gradually, it
13 The presence of lagged inflation in the hybrid New Keynesian Phillips curve signifies that the central
bank is not fully credible; this lack of credibility impairs the effectiveness of monetary policy (Ball 1995;
Woodford 2005).
14 Demertzis and Viegi (2008) present a model in which a monetary policy regime with well-defined
objectives (such as an inflation target) could help improve the anchoring of inflation expectations.
is possible to predict ex post forecast errors using ex ante changes in mean

expectations (Coibion and Gorodnichenko 2015). Carroll (2003) shows that
households’ inflation expectations are updated slowly and in part based on
media coverage of professional forecasters’ inflation projections.
Another strand of studies examines the relevance of forward- and backward-

looking expectations in the hybrid New Keynesian Phillips curve. Backward-
looking inflation expectations have been shown not to matter (that is, the
associated coefficient is not statistically significant) if the trend inflation is
determined by the long-run inflation target (Cogley and Sbordone 2008).15
Similarly, if the New Keynesian model accounts for positive trend inflation,
price-setting firms become more forward looking and the inflation rate becomes
less sensitive to current economic conditions as trend inflation increases (Ascari
and Sbordone 2014).
Anchoring of inflation expectations in advanced economies. A transparent

central bank communicates to the public its intent, strategy, assessments,
procedures, and policies in an open, clear, and timely manner. An inflation
targeting regime provides a disciplined framework that helps improve monetary
policy transparency. Broadly, the empirical work on advanced economies
suggests that monetary regimes that increase central bank transparency,
including through inflation targeting, are associated with a decrease in the
persistence of movements of inflation away from trend.
For example, in Canada, New Zealand, Sweden, and the United Kingdom,
inflation persistence disappeared after the adoption of an inflation targeting
regime (Benati 2008). In the United States, by contrast, where inflation
targeting had not yet been adopted, the persistence parameter remained low but
positive and statistically significant. These results are corroborated by
Gürkaynak, Levin, and Swanson (2010), who show that the response of market-
based inflation expectations to macroeconomic news was larger in the United
States than in Sweden and the United Kingdom. They also show that in the
United Kingdom, expectations became better anchored after the Bank of
England’s monetary policy was made operationally independent in May 1997.
Moreover, increased trust in the European Central Bank has been associated
15 Bernanke (2007) argues that the decline in the volatility of the trend component of inflation, as
estimated by the approach of Stock and Watson (2007, 2016), is consistent with the view that inflation
expectations have become better anchored. Employing the New Keynesian model, Ascari and Sbordone
(2014) show that the inflation rate becomes less sensitive to current economic conditions when trend
inflation makes price-setting firms more forward looking. Trend inflation could instead be measured
with long-term inflation expectations (Clark and Nakata 2008; Garnier, Mertens, and Nelson 2015;
Mertens 2016).
with a decline in uncertainty about future inflation in the Euro Area, thus
contributing to the anchoring of inflation expectations (Christelis et al. 2016).16
Other research studies the conditions under which inflation may not be well
anchored under an inflation targeting regime. For example, even with an
inflation targeting framework, expectations were not well anchored in New
Zealand when forecasters did not understand the central bank’s objective
function (Kumar et al. 2015). Inflation expectations in 10 advanced economies
were not as well anchored during periods of persistently below-target inflation as
during periods when inflation was close to target (Ehrmann 2015).
Several studies have examined whether inflation expectations became

unanchored during and after the global financial crisis, which was followed by a
wave of unconventional monetary policy actions. During the period
immediately following the crisis, market-based inflation expectations in the
United States and the United Kingdom became more sensitive to
macroeconomic news, but neither survey-based nor market-based long-term
inflation expectations in the Euro Area became unanchored (Galati, Heemeijer,
and Moessner 2011; Galati, Poelhekke, and Zhou 2011).
During a longer post-crisis period in the Euro Area, when inflation fell and was
persistently below target, there is evidence that the anchoring of inflation
expectations weakened (Grishchenko, Mouabbi, and Renne 2017; Garcia and
Werner 2018). The findings, which are based on different methodologies and
different measures of inflation expectations, are less consistent for the United
States, where anchoring is alternately found to have improved and deteriorated
significantly in the post-crisis period (Ciccarelli, Garcia, and Montes-Galdón
2017; Grishchenko, Mouabbi, and Renne 2017). Overall, given the size of the
shocks during the crisis, expectations in advanced economies remained fairly
well anchored (Miles et al. 2017).17
Anchoring of inflation expectations in EMDEs. Evidence on the anchoring of

inflation expectations in EMDEs is more limited, but some studies suggest that
inflation targeting plays a role (Annex 4.2). Using monthly survey data from
16 An alternative way to assess the anchoring of inflation expectations is to employ Stock and Watson’s
(2007, 2016) approach, which decomposes the inflation process into trend and volatility components.
Data for Japan, the United Kingdom, and the United States show that shocks to trend inflation are
persistent (and can be modeled as a unit root process), but that the volatility of trend inflation declined
markedly during the 1980s (Miles et al. 2017). These findings are consistent with the finding that
inflation expectations have become more firmly anchored than in the past, although not perfectly so.
17 Strohsal and Winkelmann (2015) examine the anchoring of inflation expectations, as well as the
sensitivity to news shocks, using a sample of four advanced economies. They find that the degree of
anchoring did not change during the crisis.
Consensus Economics for a sample of 22 EMDEs and 14 advanced economies

in a structural vector autoregressive model, Davis (2014) finds evidence that the
introduction of inflation targeting is associated with a statistically significant
reduction in the response of 12-month-ahead inflation expectations to shocks in
both oil prices and observed inflation. Using market-based measures of inflation
expectations for Brazil, Chile, and Mexico, De Pooter et al. (2014) document
that long-term inflation expectations became better anchored in these countries
over the preceding decade, especially in Chile and Mexico. Although they do not
specifically test for the role of inflation targeting, they ascribe this result to recent
improvements in the credibility of these countries’ central banks.
IMF (2016) estimates a hybrid New Keynesian Phillips curve using data from a
large sample of countries (24 advanced economies and 20 EMDEs). It reports
that although the coefficient on lagged inflation (backward-looking
expectations) started declining in the early 2000s, there was a reversal in this
trend in the aftermath of the Great Recession, with the coefficient returning
close to its value in the early 1990s. This study also finds that the sensitivity of
inflation expectations to macroeconomic news (proxied by the difference
between expected and realized inflation) is negatively correlated with standard
measures of central bank independence and transparency, and that expectations
become better anchored when countries adopt an inflation targeting regime.18
IMF (2018) reports that multiple measures of the degree of anchoring of
inflation expectations point to an improvement in the anchoring of expectations
over the past two decades. However, there has been considerable heterogeneity
in the extent of anchoring across emerging market economies.19
In the context of Brazil, the literature examines a wide range of factors that
might diminish the beneficial effects of inflation targeting on anchoring, broadly
concluding that central bank transparency, central bank credibility, and the
18 Estimations that allow for time-varying coefficients indicate that, although inflation expectations are
better anchored in advanced economies than in EMDEs, anchoring has improved in both groups over
time (IMF 2016). Other studies offer similar findings. Capistrán and Ramos-Francia (2010) and Mehro-
tra and Yetman (forthcoming) conclude from data for a large sample of EMDEs that inflation targeting
has affected inflation expectations. Studies of Mexico, Brazil, and South Africa find that the adoption of
inflation targeting has helped anchor expectations in each case (Carrasco and Ferreiro 2013; Cerisola and
Gelos 2009; and Reid 2009, respectively). However, Kabundi, Schaling, and Some (2015) show that, in
South Africa, even with inflation targeting, expectations of price and wage setters (businesses and trade
unions) were higher than the upper bound of the official target band, while expectations of analysts were
within the target band. This study also finds that expectations of price and wage setters were substantially
influenced by lagged inflation, but that those of analysts were not.
19 IMF (2018) focuses on four measures: absolute deviation of three-year-ahead inflation forecast
from target, variability of inflation forecasts, dispersion of inflation forecasts, and sensitivity to inflation
shocks. In the context of a small macroeconomic model, IMF (2018) also shows that better-anchored
inflation expectations reduce inflation persistence and limit the pass-through of currency movements to
domestic prices.
country’s fiscal position are all important in shaping inflation expectations. De

Mendonça and Galveas (2013) show that, when controlling for central bank
transparency, the forward-looking and hybrid specifications of the Phillips curve
are more suitable for explaining current inflation than the purely backward-
looking specifications. Yet, inflation expectations react more strongly to actual
inflation, exchange rate movements, and output shocks when there is a problem
of central bank credibility (Cortes and Paiva 2017). A deterioration in the fiscal
position could also impede the anchoring of inflation expectations because of
fears that monetary policy will be constrained, especially in cases where high
interest rates imply unstable public debt dynamics (Cerisola and Gelos 2009; de
Mendonça and Veiga 2014).20
Inflation expectations: Trends and anchors

Inflation expectations can provide valuable evidence about the credibility of a
central bank. As documented by many studies, there is a close link between
inflation expectations and monetary policy effectiveness. The more credible
households and firms consider the central bank, the more likely inflation
expectations are well anchored. In turn, well-anchored inflation expectations are
found to support the effectiveness of monetary policy. Assessing and improving
the degree of anchoring of inflation expectations are thus critical tasks for
monetary policy makers.
Evolution of inflation expectations
In both advanced economies and EMDEs, long-term (five-year-ahead) inflation

expectations have fallen during the past two to three decades. After declining
rapidly during the 1990s, inflation expectations in advanced economies
have remained stable at around 2 percent per year since the mid-2000s, with
very little cross-country variation (Figure 4.3). In EMDEs, inflation expectations
decreased markedly in the second half of the 1990s. Although they have not
regained their mid-1990s peak, expectations trended upward from 2005
to 2014, before retreating somewhat in recent years. Throughout the entire
sample period, inflation expectations in EMDEs displayed wider cross-country
dispersion than in advanced economies, as did measures of central bank
transparency. However, the rise in inflation expectations during 2005-14
coincided with an improvement in central bank transparency in EMDEs as
a group.
20 Using a dynamic stochastic general equilibrium model calibrated to the United States, Eusepi and
Preston (2018a, 2018b) conclude that government liabilities can reduce the effectiveness of monetary
policy in controlling inflation in economies with high government debt under imperfect knowledge.
Differences in anchoring between advanced economies and EMDEs. If

inflation expectations are well anchored, they should be relatively insensitive to
news, because economic agents assume that transitory shocks do not affect
inflation over the long run. The degree of anchoring can be assessed empirically
by regressing changes in five-year-ahead inflation expectations on
macroeconomic news.21 Relevant news can be proxied by inflation shocks—the
difference between realized inflation and short-term inflation expectations in the
previous period (that is, six months prior). Following earlier studies, this chapter
employs two simple empirical strategies to study the extent of anchoring
inflation expectations: a panel regression model with country and time fixed
effects, and a time-varying model that provides a flexible framework to track
time variation in the degree of anchoring (Annex 4.3). The first approach
provides an overview of how well expectations are anchored in different country
groups (for example, advanced economies versus EMDEs) and time periods. The
second approach shows how country-specific and time-varying measures of the
degree of anchoring have evolved.
The empirical exercises produce three major results. First, the sensitivity of long-
term (five-year-ahead) inflation expectations to inflation shocks in both
advanced economies and EMDEs is greater than zero for 1990-2018, indicating
imperfect anchoring of inflation expectations (Figure 4.4; Annex 4.4). Second,
the sensitivity is lower in advanced economies than in EMDEs, and the
difference in sensitivity between these two groups is statistically significant. This
finding, which indicates that expectations are better anchored in the advanced
economies, is consistent with the view that monetary policy is less credible in
EMDEs than in advanced economies.
Third, in both country groups, inflation expectations have become better
anchored over time (that is, coefficients for both country groups are statistically
significantly smaller in the latter time periods). Especially during 2005-18,
expectations in advanced economies are found to have been very well anchored
(the coefficient is not statistically significantly different from zero). In EMDEs,
anchoring improved markedly during 2005-18, despite the slight increase in
inflation expectations in these economies since 2005.
21 The sensitivity of long-term inflation expectations to inflation shocks is used in this chapter to
measure the degree of anchoring of inflation expectations. This measure is employed in several previous
studies (Beechey, Johannsen, and Levin 2011; Galati, Poelhekke, and Zhou 2011; Gürkaynak, Levin, and
Swanson 2010; IMF 2016; Garcia and Werner 2018; De Pooter et al. 2014). Other previous studies
employ different measures of anchoring of inflation expectations: the deviation of long-term inflation
expectations from an inflation target (Buono and Formai 2018; Bordo and Siklos 2017), variance of
inflation expectations (Grishchenko, Mouabbi, and Renne, 2017), and dispersion of inflation forecasts
(Capistrán and Ramos-Francia 2010). These measures are highly correlated (IMF 2018). The measure
employed here is useful for at least three reasons: it is available for a large sample of countries; it can be
used in a time-varying model; and the findings using it can be compared to others in the literature.
FIGURE 4.3 Long-term inflation expectations
Long-term (five-year-ahead) inflation expectations in advanced economies declined during

the 1990s. Since the mid-2000s, they have remained stable at around 2 percent, with
limited cross-country variation. Inflation expectations in EMDEs also fell in the second half
of the 1990s, but have risen somewhat since 2005, and remain higher than in advanced
economies. Inflation expectations in EMDEs also display wider cross-country dispersion.
Among EMDEs, those with highly transparent central banks have relatively lower inflation
expectations.
A. Inflation expectations, advanced B. Inflation expectations, EMDEs

economies
C. Central bank transparency, advanced D. Central bank transparency, EMDEs

economies
E. Share of economies with declines in F. Inflation expectations, EMDEs

inflation expectations, 1995-2018
Source: Consensus Economics; Dincer and Eichengreen 2014; International Monetary Fund; World Bank.
A.B.E.F. Inflation expectations are five-year-ahead expectations of annual inflation.
A. Based on a sample of 24 advanced economies during 1990H1-2018H1.
B. Based on a sample of 23 EMDEs during 1995H1-2018H1.
C. Based on a sample of 24 advanced economies.
D.F. Based on a sample of 23 EMDEs.
F. High (low) transparency countries are defined as those with central bank transparency above the 75th (below the 25th)
percentile of EMDEs.
Roles of global and domestic shocks in anchoring inflation

expectations
The time-varying model described above is extended to estimate the response of
inflation expectations to shocks from two sources, global and domestic.
Examples of domestic shocks include unexpected electoral outcomes, wage
disputes, and currency movements. Global shocks (surprises) could stem from
sudden movements in food prices, oil prices, global economic activity, and
financial conditions in major advanced economies.22 In the model, a global
inflation shock is defined as the first principal component of national inflation
shocks for the full sample of countries (Annex 4.3). A domestic inflation shock is
defined as the residual from a regression of the national inflation shock on the
global inflation shock.
The regressions produce four major results (Figure 4.5). First, for the median
economy in each country group, the sensitivity of inflation expectations to both
types of shocks is positive, indicating imperfect anchoring. Second, in the case of
advanced economies, there was a gradual decline in the sensitivity of inflation
expectations to global shocks from the 1990s to the late 2000s, followed by a
large one-time drop during the global financial crisis. There was a much less
pronounced downward trend in the sensitivity of inflation expectations to
domestic shocks than to global shocks. These results imply that, in advanced
economies, the improved anchoring of expectations has been partly driven by
the reduction in the sensitivity of inflation expectations to global shocks.
Third, for EMDEs, the sensitivity of inflation expectations to domestic shocks
gradually fell during 2005-12, and since 2012 has been stable. There has also
been a slight decline in the sensitivity of expectations to global shocks since
2000. Finally, inflation expectations appear to be more sensitive to both global
and domestic shocks in EMDEs than in advanced economies, implying weaker
anchoring of expectations in the former group. The robustness of the results is
tested by replacing the global shock, as described above, with an oil price shock,
food price shock, global liquidity shock, and global output gap shock. These
exercises lead to broadly consistent findings with the headline results.
Determinants of anchoring expectations

The improved anchoring of five-year-ahead inflation expectations over time in
advanced economies and EMDEs, as suggested by the time-varying model in the
22 De Pooter et al. (2014) examine how foreign and domestic news surprises affect (market-based)
inflation expectations in Brazil, Chile, and Mexico, using daily data. In their framework, foreign news
surprises stem from macroeconomic developments in the United States and China and fluctuations in oil
and food prices. They report that U.S. nonfarm payroll data releases have a significant impact on
long-term inflation expectations in Chile and Mexico, while there is no corresponding impact in Brazil.
The impact of news related to oil and food prices is not statistically significant.
FIGURE 4.4 Sensitivity of inflation expectations to inflation shocks
The sensitivity of long-term inflation expectations to inflation shocks has fallen in the past
decade in both advanced economies and EMDEs but remains comparatively higher in
EMDEs. A similar pattern is observed when measuring the sensitivity of expectations using
a time-varying model.
A. Sensitivity of inflation expectations to B. Sensitivity of inflation expectations to

inflation shocks inflation shocks, all countries

inflation shocks, advanced economies inflation shocks, EMDEs

A.-D. Inflation expectations are five-year-ahead expectations of annual inflation. Inflation shocks are defined as the
difference between realized inflation and short-term inflation expectations in the previous period.
Sensitivity is estimated using a panel regression of the change in five-year-ahead inflation expectations on inflation shocks,
as described in Annex 4.3. Bars denote medians and vertical lines denote 90 percent confidence intervals. Based on a
sample of 24 advanced economies and 23 EMDEs during 1990H2-2018H1.
B.-D. Time-varying sensitivity is estimated by regressing the change in five-year-ahead inflation expectations on inflation
shocks, as described in Annex 4.3. Solid lines denote the median of estimates and the dotted lines indicate the median of
68 percent confidence intervals.
B. Based on a sample of 24 advanced economies and 23 EMDEs during 2000H1-2018H1.
C. Based on a sample of 24 advanced economies during 1995H1-2018H1.
D. Based on a sample of 23 EMDEs during 2000H1-2018H1.
previous section, may be associated with policy reforms aimed at increasing

central bank credibility since the early 1990s (Mishkin 2007). Using the
estimated sensitivity of inflation expectations as a dependent variable, panel
regression models are used to assess which factors determine the degree of
anchoring of expectations (Annex 4.3). The explanatory variables in the models
include the presence of an inflation targeting regime, central bank transparency,
the presence of a fixed exchange rate regime, financial openness, trade openness,
and fiscal sustainability.
FIGURE 4.5 Sensitivity of inflation expectations to global and

domestic inflation shocks
Inflation shocks can be associated with global and domestic factors. Long-term inflation
expectations in EMDEs are more sensitive to both global and domestic shocks than are
inflation expectations in advanced economies.

global shocks, all countries domestic shocks, all countries

global shocks, advanced economies domestic shocks, advanced economies
E. Sensitivity of inflation expectations to F. Sensitivity of inflation expectations to

global shocks, EMDEs domestic shocks, EMDEs
Source: World Bank.

A.-F. Inflation expectations are five-year-ahead expectations of annual inflation.
A.-F. Time-varying sensitivity is estimated by regressing the change in five-year-ahead inflation expectations on global and
domestic shocks, as described in Annex 4.3. Solid lines denote the median of estimates and dotted lines indicate the
median of 68 percent confidence intervals.
A.B. Based on a sample of 24 advanced economies and 23 EMDEs during 2000H1-2018H1.
C.D. Based on a sample of 24 advanced economies during 1995H1-2018H1.
E.F. Based on a sample of 23 EMDEs during 2000H1-2018H1.
Inflation targeting and central bank transparency. If central banks in advanced

economies are perceived as credible, they can successfully anchor inflation
expectations without explicit inflation targets or formal transparency rules.
However, in EMDEs, where central banks still need to build credibility, explicit
targets and transparency rules are more likely to be necessary to anchor
expectations. The regression results show that the coefficient on inflation
targeting is statistically significant and negative, meaning it is associated with
lower sensitivity of inflation expectations to shocks (Figure 4.6).23 For central
bank transparency, the coefficient is only statistically significant and negative for
the full sample of countries and the EMDE subsample. Central bank
transparency has improved in EMDEs over the past two decades. In advanced
economies, although the degree of central bank transparency is higher than in
EMDEs, it has not changed much during this period.
Financial integration and exchange rate regime. Financial integration appears to

exert a disciplining effect on macroeconomic policy (Tytell and Wei 2004;
Gupta 2008; Kose et al. 2010). For example, integration could raise the cost of
loose monetary policy in the form of larger capital outflows. However, more
financially open economies are more vulnerable to external shocks, which may
make it more difficult for policy makers to anchor inflation expectations. The
results indicate that the correlation between financial openness and the
anchoring of inflation expectations is not statistically significant for the full
sample of countries or the EMDE subsample. However, as documented above,
long-term inflation expectations in EMDEs are more sensitive to global shocks.
Hence, large external shocks could offset the benefits of financial integration to
anchoring expectations in EMDEs.
The use of pegged exchange rates might be a signal for a credibility crutch in
countries with limited monetary policy credibility (Levy Yeyati, Sturzenegger,
and Reggio 2010). As is well-known from the impossible trinity argument,
employing a fixed exchange rate regime when capital movements are free could
hamper the independence of monetary policy.24 Although the exchange rate
regime by itself does not appear to be relevant for anchoring inflation
expectations, the results show that when financial openness is interacted with the
fixed exchange rate regime dummy, the interaction term becomes significant.
23 Capistrán and Ramos-Francia (2010) also find that inflation targeting affects inflation expectations
only in EMDEs, with no effect on the dispersion of inflation expectations in advanced economies. They
argue that given the recent relative stability of inflation in advanced economies, professional forecasters
may have homogeneous views about future inflation, so that the dispersion remains unchanged even after
the introduction of an explicit inflation target.
24 The impossible trinity is the argument that a country cannot have more than two of the following:
fixed exchange rate, free capital movement, and independent monetary policy. As a result, countries with
inflation targeting regimes typically also operate with flexible exchange rates (De Gregorio 2009a).
FIGURE 4.6 Determinants of the sensitivity of inflation expectations

to shocks
Long-term inflation expectations in EMDEs are found to be better anchored in the presence
of an inflation targeting regime, a high degree of central bank transparency, low public
debt, and a high degree of trade openness.
A. Impact of inflation targeting regime B. Impact of one-unit increase in central bank

(dummy) on sensitivity of inflation transparency index on sensitivity of inflation
expectations expectations
C. Impact of fixed exchange rate regime D. Impact of one-unit increase in financial

(dummy) on sensitivity of inflation openness index on sensitivity of inflation
expectations expectations
E. Impact of 10 percentage point increase in F. Impact of 10 percentage point increase in

trade openness (import penetration) on public debt-to-GDP ratio on sensitivity of
sensitivity of inflation expectations inflation expectations
Sources: Chinn and Ito 2017; Dincer and Eichengreen 2014; International Monetary Fund; Shambaugh 2004; World Bank.
Note: DOLS = dynamic ordinary least squares; EMDEs = emerging market and developing economies; FMOLS = fully
modified ordinary least squares; GDP = gross domestic product.
A.-D. Inflation expectations are five-year-ahead expectations of annual inflation. Bars denote coefficients of panel
regressions of 24 advanced economies and 23 EMDEs using annual data for 1995-2016, as described in Annex 4.3.
Vertical lines denote 90 percent confidence intervals.
D. Financial openness x exchange rate regime is the interaction of these two explanatory variables.
E.F. Bars denote coefficients of group mean panel FMOLS and group mean DOLS regressions of 24 advanced economies
and 23 EMDEs using annual data for 1995-2016, as described in Annex 4.3. Vertical lines denote 90 percent confidence
intervals.
This result suggests that the exchange rate regime does matter for anchoring
inflation expectations in more financially open economies.25
Trade integration. Trade integration could affect inflation expectations through

competition in product markets that could increase the responsiveness of
domestic prices to shocks. For example, one line of research finds that higher
price flexibility steepens the Phillips curve, reducing the short-run output gain
from a monetary expansion, and lowering the incentive for central banks to
adopt inflationary policies (Romer 1993; Rogoff 2006). Alternatively,
outsourcing of labor through global value chains may reduce the responsiveness
of wages to domestic labor market conditions and hence flatten the Phillips
curve (Blanchard, Cerutti, and Summers 2015; Blanchard 2016; Miles et al.
2017). However, at least for the United States, lower marginal costs, rather than
globalization, are the key driver of the flattening of the Phillips curve.26
The regression results show that the correlation between import penetration and
sensitivity of inflation expectations to shocks is negative and statistically
significant for the subsample of EMDEs. Thus, for EMDEs only, the anchoring
of inflation expectations improves as import penetration rises, consistent with
theories suggesting that globalization is associated with improved anchoring.27
Fiscal sustainability. Inflation expectations are unlikely to be well anchored if

there are questions about fiscal sustainability because of fears that monetary
policy will be constrained, especially in cases where high interest rates imply
unstable public debt dynamics. The regression results for the full sample of
countries, and for the EMDE subsample, are consistent with this prediction,
showing a positive and statistically significant correlation between the ratio of
25 The baseline regressions use Chinn and Ito’s (2017) de jure measure of financial openness and
Shambaugh’s (2004) classification of exchange rate regimes. The baseline results do not change when a de
facto measure of capital account liberalization (sum of foreign assets and liabilities as percentage of GDP)
and an alternative measure of exchange rate regime classification (from Ilzetzki, Reinhart, and Rogoff
2017) are used as explanatory variables.
26 The empirical literature examining whether globalization affects domestic inflation produces mixed
results. For example, Calza (2009) and Ihrig et al. (2010) find no robust evidence that global slack affects
the parameters of the inflation process. Gaiotti (2010) finds that the flattening of the Phillips curve is due
to globalization. In contrast, Borio and Filardo (2007) argue that global slack may become a key driver of
domestic inflation, while Auer, Borio, and Filardo (2017) show that the rise of global value chains has
amplified the importance of global slack in driving domestic inflation. Forbes (2018) suggests that
inflation models should allow key global factors, including global slack, to adjust over time. As a
robustness check, government effectiveness (measured by the World Bank’s Worldwide Governance
Indicators) is also included as an explanatory variable in the regressions here. It is not statistically
significant.
27 Using a New Keynesian model, Martínez-García (2017) argues that the impact of globalization on
monetary policy effectiveness is underestimated if the analysis uses the standard trade openness measures,
and that what matters is the elasticity of substitution between locally produced and imported goods.
public debt to GDP and the sensitivity of long-term inflation expectations to

inflation shocks.28
Anchoring expectations: Country experiences

The findings from the empirical exercises on the degree and determinants of
inflation anchoring in advanced economy and EMDE country groups are
broadly consistent with the behavior of inflation expectations at the country
level. Yet, there are still lessons to be learned from individual countries’
experiences.
Among advanced economies, the sensitivity of inflation expectations to inflation
shocks tends to be lower under inflation targeting. Yet, at the country level,
inflation targeting does not necessarily guarantee firm anchoring of inflation
expectations (Figure 4.7). In Canada, New Zealand, and the United Kingdom,
for instance, the sensitivity of expectations to inflation shocks has been close to
zero since 2000. In these countries, the early introduction of inflation targeting
may have helped anchor expectations.29 Japan has had difficulty anchoring
expectations after introducing its inflation targeting regime in 2013, perhaps
because of its recent history of persistently low inflation. Inflation expectations
are not as well anchored under persistently below-target inflation as when
inflation is close to target (Ehrmann 2015).
In the Euro Area, where the European Central Bank’s main objective since its
inception in 1999 has been to maintain price stability (defined as inflation of less
than, but close to, 2 percent in the medium term), the sensitivity of inflation
expectations was lower than that in the United States in 2005 (Beechey,
Johannsen, and Levin 2011). This pattern reversed in 2010-15, when sensitivity
in the United States was close to zero—lower than that in the Euro Area—due
in part to persistent undershooting of the European Central Bank’s target and
perhaps also to the U.S. Federal Reserve’s adoption of an official inflation target
in 2012.30
28 De Mendonça and Veiga (2014) argue that even under an inflation targeting regime, interest rate
hikes to reach target inflation imply increases in the primary surplus required for stabilizing the public
debt, and that this fiscal deterioration could constrain monetary policy. These authors also show that the
public-debt-to-GDP ratio has a statistically significant relationship with the deviation between inflation
and its target.
29 New Zealand, Canada, the United Kingdom, and Korea introduced inflation targeting in 1990,
1991, 1992, and 1998, respectively. Kumar et al. (2015) argue that expectations (based on firm-level data
rather than those of professional forecasters) are not well anchored in New Zealand because forecasters do
not understand the central bank’s objective function. Yetman (2017) and Beaudry and Ruge-Murcia
(2017) find that the implementation of inflation targeting in Canada and the United Kingdom has been
more successful than that in other inflation targeting countries.
30 Garcia and Werner (2018) find that there has been a decline in the extent of anchoring inflation
expectations in the Euro Area since 2013.

The record of EMDE central banks in anchoring inflation expectations under

inflation targeting regimes has been mixed. Annex 4.5 provides case studies for
Brazil, Chile, and Poland. In Brazil, although long-term inflation expectations
have been relatively stable under the inflation targeting regime that began in
1999, the sensitivity of expectations to shocks remains elevated relative to that in
Chile and Poland. Less than ideal fiscal conditions and worsening central bank
transparency during part of the inflation targeting period may have contributed
to this outcome (Cerisola and Gelos 2009; de Mendonça and Galveas 2013; de
Mendonça and Veiga 2014).
In contrast, Chile has had considerable success: the sensitivity of inflation

expectations to shocks has for some years been close to the median for advanced
economies. The gradual introduction of inflation targeting in the 1990s gave the
central bank time to build its credibility. From the outset of the inflation
targeting regime, the central bank pursued a robust communications effort that
included the publication of a quarterly Monetary Policy Report with strong
analytical content.31 Chile’s adoption of an inflation target as part of a
comprehensive, credible macroeconomic policy framework may have helped
generate favorable macroeconomic outcomes (De Gregorio, Tokman, and
Valdés 2005; Valdés 2007).
Poland has also succeeded with inflation targeting, which it began in 1999, even
though domestic financial markets were immature, and the central bank had
limited knowledge of monetary policy transmission at the time of introduction.
The transition to a flexible exchange rate regime concurrent with the adoption
of inflation targeting may have helped to anchor expectations. Over time,
inflation expectations fell, eventually settling near the policy target rate, and the
sensitivity of expectations to shocks became quite low.
In India and South Africa, the sensitivity of inflation expectations to shocks fell
markedly after the introduction of inflation targeting. In South Africa, the
combination of inflation targeting and consistently high central bank
transparency may have been key to anchoring expectations.32 In India, however,
lagged inflation, as well as current and lagged changes in fuel and food prices,
have been found to have significantly affected inflation expectations (Benes et al.
2017; Patra and Ray 2010).
31 For instance, the Central Bank of Chile’s quarterly inflation report included, from its inception,
inflation forecasts with confidence intervals displayed in fan charts of the type pioneered by the Bank of
England (Mishkin 2007).
32 Kabundi, Schaling, and Some (2015) and Miyajima and Yetman (2018) show that, even in the
presence of an inflation targeting framework, expectations of price setters (businesses and unions) in
South Africa are higher than the upper bound of the official target band; the expectations of analysts are
within the target band. In addition, expectations of price setters put a greater weight on past inflation,
whereas analysts’ expectations are more forward looking.
FIGURE 4.7 Time-varying sensitivity of inflation expectations to

shocks: Country experiences
Inflation targeting does not guarantee the anchoring of long-term inflation expectations.
However, sensitivity to inflation shocks in advanced economies with inflation targets tends
to be low. The success of central banks in emerging market and developing economies in
anchoring inflation expectations under inflation targeting has been mixed.

inflation shocks, advanced economies (1) inflation shocks, advanced economies (2)

inflation shocks, Europe and Central Asia inflation shocks, Latin America
E. Sensitivity of inflation expectations to F. Sensitivity of inflation expectations to

inflation shocks, India inflation shocks, South Africa
Source: World Bank.

A-F. Inflation expectations are five-year-ahead expectations of annual inflation. Time-varying sensitivity is estimated by
regressing long-term inflation forecast revisions on inflation shocks. Vertical lines denote 68 percent confidence intervals.
The model is described in Annex 4.3.
B. The Euro Area here comprises Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands,
Portugal, and Spain.
Mexico has been less successful than Chile in anchoring inflation expectations
under an inflation targeting regime. The Bank of Mexico did not publish its
own inflation forecasts for several years after adopting inflation targeting (Batini
and Laxton 2006; De Pooter et al. 2014). Over time, however, the central
bank’s communication strategy has improved, and it now publishes its inflation
forecasts and releases the minutes of its monetary policy meetings (Carrasco and
Ferreiro 2013). Finally, in Russia, high, positive sensitivity of inflation
expectations to inflation shocks may reflect low central bank transparency
(Dincer and Eichengreen 2014). However, Russia is relatively new to inflation
targeting, having introduced the regime in 2015.
Conclusion
This chapter contributes to the literature on inflation expectations in EMDEs by
answering three questions. First, how does the degree of anchoring of long-term
inflation expectations differ between advanced economies and EMDEs? Second,
how sensitive are inflation expectations to global and domestic shocks? Third,
what are the main determinants of the degree of anchoring of inflation
expectations? The principal conclusions are the following:
• Long-term inflation expectations have declined and become more firmly

anchored in the past two decades in both advanced economies and EMDEs.
However, anchoring in EMDEs remains notably weaker than in advanced
economies. This finding is consistent with the view that monetary policy is
less credible in EMDEs than in advanced economies.
• Long-term inflation expectations in EMDEs are more sensitive to both

global and domestic shocks than are inflation expectations in advanced
economies. The sensitivity of EMDE inflation expectations to domestic
shocks gradually fell between 2005 and 2012 and has since been mostly
stable, while the sensitivity of EMDE inflation expectations to global shocks
has fallen slightly since 2000. In advanced economies, a large drop in the
sensitivity of inflation expectations to global shocks in the wake of the
global financial crisis followed a steady decline from the late 1990s to the
late 2000s; there has been a much less pronounced downward trend in
sensitivity to domestic shocks. These findings suggest that the improvement
in the anchoring of inflation expectations in advanced economies is partly
due to the decline in sensitivity to global shocks.
• The institutional and monetary policy environment matters for the

anchoring of inflation expectations, as do the general macroeconomic
environment and structural characteristics of the economy. The chapter
finds that the presence of an inflation targeting regime and a rise in central
bank transparency are associated with better anchoring of long-term
inflation expectations. For EMDEs, lower public debt and greater trade
openness are also associated with better anchoring of expectations. This
finding implies that the anchoring of inflation expectations in EMDEs
depends not only on monetary policy, but also on structural factors and
fiscal policy. Case studies for Brazil, Chile, and Poland provide examples of
these multiple factors at work. In Brazil, for instance, fiscal policy, together
with backtracking on central bank transparency for a period, may have held
back progress on improving the anchoring of inflation expectations. In
Chile, a highly transparent central bank, together with a credible
macroeconomic framework, may have contributed to the central bank’s
success in achieving well-anchored inflation expectations. And in Poland,
the simultaneous adoption of inflation targeting and a floating exchange
rate regime may have helped anchor expectations.
Although inflation expectations have become significantly better anchored

during the past decade, the results show that there is still room for
improvement, especially in EMDEs. Although inflation targeting seems to have
been useful in reducing the sensitivity of inflation expectations to shocks,
inflation targeting should not be considered necessary or sufficient for improved
anchoring of expectations. The overall macroeconomic policy framework,
including fiscal conditions and the transparency of the central bank, is also
important for success.
These findings point to several research avenues to explore. First, research could
examine the determinants of a wider range of measures of inflation expectations
in EMDEs. This research direction would be particularly worthwhile if data
availability could be improved. Second, it would be useful to consider
nonlinearities between institutional factors and the anchoring of inflation
expectations. In addition, there is a need to investigate how complementarities
between institutional factors and fiscal and monetary policy frameworks help
improve the anchoring of inflation expectations.
ANNEX 4.1 Primer on expectations and monetary

policy
The effectiveness of monetary policy depends on expectations, particularly about
the future policy stance. Moreover, there is broad agreement that economic
agents form their expectations by extracting signals from their experience of
actual policies. Over time, there has been an evolution of views on this topic,
which is reflected in the development of the models describing the links between
expectations and monetary policy. This annex presents a brief history of the
evolution of views on the topic.
Traditional Keynesian models
The birth of modern macroeconomics is usually associated with the publication
of Keynes’ (1936) General Theory of Employment, Interest and Money. However,
the backdrop for Keynes’s analysis was the Great Depression, a period of low or
negative inflation and stagnant nominal wages (Samuelson and Solow 1960).
The General Theory had little to say directly about the issue of inflation and, for
simplicity, assumed that money wages were fixed. As the economy recovered,
and with World War II posing a new set of challenges due to higher government
expenditure, Keynes later discussed the trade-off between excess demand and
wage and price inflation (Keynes 1940).
By the 1950s, inflation was becoming more of a problem for policy makers, and
Phillips (1958) provided a breakthrough, with statistical evidence on a negative
relationship between the unemployment rate and wage inflation in the United
Kingdom. The Phillips curve became a standard feature of subsequent Keynesian
macroeconomic models. Samuelson and Solow (1960) famously developed the
notion of a policy trade-off between reduced unemployment (or increased
output) and lower inflation. However, they also pointed out that this trade-off
might not be stable.
Friedman (1968) established that adaptive inflation expectations would disrupt
this trade-off. A change in the expected rate of inflation would shift the
short-run Phillips curve, and over time output and unemployment would return
to their long-run equilibrium values, regardless of the rate of inflation.
Keynesian modelers incorporated the concepts of endogenous expectations and
the natural rate of unemployment (or, equivalently, potential output) into their
estimated Phillips curves. Policy makers would no longer be able to run the
economy “hot” without facing accelerating inflationary pressure.
Views advanced by Friedman and Phelps
Friedman (1968) forcefully argued that estimates of a stable relationship
between inflation and unemployment would exist only when inflation
expectations were well anchored. He warned that any attempt to exploit the
short-run relationship as if it were permanent would cause expectations to
become unanchored, leading to a shift in the Phillips curve. Thus, starting at the
natural rate of unemployment, a stimulative monetary policy would lead to
higher inflation without any benefit in terms of lower unemployment in the
long run.
Friedman’s point—made independently by Phelps (1967)—was that rational
workers care only about real wages, and that real wages need to adjust so that
labor supply equals labor demand at a uniquely determined natural rate of
unemployment. An expansionary monetary (or fiscal) policy aimed at pushing
unemployment below the natural rate would lead to an increase in aggregate
demand, which would then feed into both higher prices and wages. If the
increase in wages is smaller than the increase in prices, firms are willing to hire
more workers because the real wage has decreased. However, workers will soon
realize that their real wage has decreased and request wage increases that match
price inflation. The outcome is a rightward shift of the Phillips curve with an
equilibrium characterized by higher inflation and unemployment back at the
natural rate. In this framework, the short-run Phillips curve is negatively sloped,
but it shifts up the vertical long-run Phillips curve.
In the expectations-augmented Phillips curve, inflation depends on expected
inflation as well as the deviation between actual unemployment and the natural
rate of unemployment. In the long run, expected inflation is always equal to
actual inflation and unemployment is always at the natural rate. However, the
short-run Phillips curve will move up as expectations adjust, eventually to a
point where a new short-run Phillips curve crosses the vertical long-term curve.
The new equilibrium will be characterized by higher inflation and no gains in
terms of lower unemployment. Any attempt to keep the unemployment rate
below its natural level would require a continuous acceleration of inflation. A
corollary of the expectations-augmented Phillips curve is that, in the long run,
the natural rate of unemployment is compatible with any rate of inflation and
the rate of inflation is completely driven by economic agents’ expectations of
future inflation.
In the Friedman-Phelps formulation of the Phillips curve, there is a short-run
trade-off between inflation and economic activity. Lucas (1972) introduced
rational expectations about monetary policy itself into macroeconomic models.
This led Sargent and Wallace (1975, 1976) to conclude that systematic
monetary policy is irrelevant even in the short run. In this new classical
approach, forward-looking agents incorporate policy makers’ reaction function
into their expectations and thus make policy actions ineffective by fully
anticipating them. In this view, only random (that is, surprise) changes in
monetary policy can affect the real economy.
New Keynesian model

It soon became clear that the policy irrelevance proposition required the
assumption of fully flexible prices and wages. Pioneering work by Fischer
(1977), Taylor (1980), Rotemberg (1982), and Calvo (1983) showed that in the
presence of staggered contracts monetary policy can be effective even under the
assumption of rational expectations. Calvo’s pricing model is one of the key
building blocks of modern New Keynesian models. This workhorse model
combines forward-looking optimizing agents with monopolistic competition
and sticky prices. Although agents are assumed to have full-information rational
expectations (FIRE), in the presence of distortions associated with market power
and sticky prices, monetary policy can be welfare enhancing and achieve an
efficient allocation of resources.
In effect, the New Keynesian approach reverts to ideas first clearly expressed in
the writings of Keynes’s contemporary, Hawtrey (for example, Monetary
Reconstruction, 1923). Hawtrey argued that the effectiveness of monetary policy
depends on expectations about the future policy stance and that agents form
their expectations by extracting signals from the current policy actions. This
view underlies the endogenous expectations in modern monetary economics (for
example, Woodford 2003).
The standard New Keynesian Phillips curve describes inflation as a function of
expected inflation and the output gap (Galí and Gertler 1999). This curve is the
basis of Bernanke’s (2007) statement that expectations “greatly influence actual
inflation and thus the central bank’s ability to achieve price stability.” In
addition, expectations affect the transmission of monetary policy through the
term structure of interest rates and changes in asset prices. Although the central
bank can control the short-term nominal interest rate, investment and
consumption decisions depend on the long-term real interest rate, which, in
turn, depends on expectations about long-term inflation and future movements
of the short-term nominal rate.1 Economic decisions are also affected by
movements in asset prices (wealth effects), which again depend on expected real
returns. A problem with the standard New Keynesian Phillips curve is that it
does not fit the data well. Fuhrer (1997) documents that inflation expectations
are not significant in explaining inflation using a purely forward-looking model.
Several studies employ the hybrid New Keynesian Phillips curve, in which
current inflation depends on both expected and lagged inflation (Galí and
Gertler 1999).
1 Although the New Keynesian Phillips curve allows for a short-term trade-off between inflation and
unemployment, it maintains the neoclassical view that there is no long-run trade-off. However, at low
levels of inflation, the long-run Phillips curve may become negatively sloped and allow for such a trade-off
(Akerlof, Dickens, and Perry 2000; Benigno and Ricci 2011). Blanchard (2016) argues that the Great
Recession led to a substantial anchoring of inflation expectations and that now the U.S. Phillips curve
looks more like the Phillips curve of the 1960s than the accelerationist Phillips curve of standard New
Keynesian models.
ANNEX 4.2 Studies on the anchoring of inflation expectations
TABLE A.4.2.1 Studies on advanced economies

Economies (sample
Authors Questions Methodology Results
period and frequency)
Australia, Canada, New
The implementation of inflation targeting in Canada has
Beaudry and Has inflation targeting Zealand, Sweden, United
been particularly successful compared with the
Ruge-Murcia been successful in Kingdom, and United Descriptive statistics
experiences of other inflation targeting countries and the
(2017) Canada? States (1991-2016,
United States.
monthly and quarterly)
Are inflation
Beechey,
expectations anchored Regression of changes in
Johannsen, Euro Area and the United Inflation expectations are better anchored in the Euro Area
more firmly in the Euro inflation expectations on
and Levin States (2003-07, daily) than in the United States.
Area than in the United macroeconomic news
(2011)
States?
How are households’ Regression of household
United States (1981-2000, Household forecasts are affected by media and
Carroll (2003) inflation expectations expectations on professional
quarterly) professional forecasts.
formed? forecasts or news

Did the financial crisis
Ciccarelli, Estimating the time-varying
and the Great Recession
Garcia, and United States (2005-15, coefficient measuring the pass- The anchoring of inflation expectations has deteriorated
affect the anchoring of
Montes-Galdón monthly) through from short- to long- significantly since late 2008.
long-term inflation
(2017) term inflation expectations
expectations??
Was the absence of Regression of difference The absence of disinflation during 2009-11 can be
Coibion and disinflation during the between household and attributed to rising inflation expectations, which were in
United States (1981-2013,
Gorodnichenko Great Recession linked professional inflation turn affected by rising oil prices.
monthly)
(2015) to a change in inflation expectations on the change in
expectations? oil price
Regression of inflation Inflation expectations are not as well anchored when

CHAPTER 4
How do inflation
Ehrmann 10 advanced economies expectations on lagged inflation inflation is persistently low as when inflation is around the
expectations behave
(2015) (1990s-2014, monthly) and dummy variable for times target: inflation expectations are more dependent on
under inflation targeting?
of (persistently) low inflation lagged inflation.
235
TABLE A.4.2.1 Studies on advanced economies (continued) 236
Economies (sample
period and frequency)
Galati, Test for anchoring by regression There is some evidence that market-based inflation
Did the global financial Euro Area, United
Poelhekke, of changes in inflation expectations in the United Kingdom and the United
crisis affect inflation Kingdom, and United
CHAPTER 4
and Zhou expectations on macroeconomic States became more sensitive to macroeconomic news
expectations? States (2004-09, daily)
(2011) news during the global financial crisis.
Test for anchoring by regression
Are Euro Area inflation Euro Area, Germany,
Garcia and of changes in inflation The anchoring of inflation expectations has weakened
expectations well Italy, and Spain (2005-
Werner (2018) expectations on macroeconomic in the Euro Area since 2013.
anchored? 17, daily)
news
Estimation of inflation
Grishchenko, Are long-term inflation expectations and inflation
Euro Area and United Inflation anchoring improved in the United States, while
Mouabbi, and expectations well uncertainty by dynamic latent
States (1999:1-2016:2) mild de-anchoring occurred in the Euro Area.
Renne (2017) anchored? factor model with stochastic
volatility
Gürkaynak, Sweden, United Test for anchoring by regression The response of market-based inflation expectations to
Does inflation targeting
Levin, and Kingdom, and United of changes in inflation macroeconomic news is larger in the United States than
anchor long-term inflation
Swanson States (1990s to early expectations on macroeconomic in Sweden and the United Kingdom. Inflation targeting
expectations?
(2010) 2000s, daily) news affects long-term inflation expectations.
1. The coefficient on lagged inflation started declining in

1. Estimation of a hybrid New the mid-1990s, but this trend reversed in the aftermath
1. Have inflation Keynesian Phillips curve of the Great Recession, and the coefficient is now
expectations become (regression of actual inflation on similar to that in the early 1990s.
increasingly sensitive to inflation expectations, past
inflation outturns in recent 24 advanced economies inflation, and other control 2. The sensitivity of inflation expectations to macro-
years? variables) economic news is inversely correlated with standard
IMF (2016) and 20 EMDEs measures of central bank independence and trans-
2. How do monetary (1990s-2016) 2. Test for anchoring by parency; expectations become better anchored when
policy frameworks affect regression of changes in inflation countries adopt an inflation targeting regime.
the degree of anchoring expectations on macroeconomic Estimations that allow for time-varying coefficients
of inflation expectations? news, using a time-varying indicate that, while expectations are better anchored in
parameter model advanced economies, anchoring has improved in both
advanced economies and EMDEs.
TABLE A.4.2.1 Studies on advanced economies (continued)
Economies
Authors Questions (sample period Methodology Results
and frequency)
Firm managers display little anchoring of inflation
expectations, despite 25 years of inflation
targeting by the Reserve Bank of New Zealand.
Are firms’ inflation
Kumar et al. New Zealand Managers are generally poorly informed about
expectations well Quantitative survey of cross-section of firms
(2015) (2014Q3-2014Q4) recent inflation dynamics. Their forecasts of
anchored?
future inflation reflect high levels of uncertainty
and are volatile at both short- and long-run
horizons.
Australia, Canada, Comparison of forecasts of actual inflation with
Does inflation targeting New Zealand, predicted forecasts, which are derived by
Johnson Inflation targeting stabilizes long-term inflation
affect long-term inflation Sweden, and the multiplying the estimated coefficients of Phillips
(2003) expectations.
expectations? United Kingdom curves using the same independent variables
(1990s, monthly) before and after the target announcement
Regression of deviations of long-term inflation

Inflation expectations in the United States
Strohsal, Did the global financial United States expectations from the inflation target on
became partially de-anchored during the global
Melnick, and crisis affect inflation (2004-14, observed inflation or news-driven short-term
financial crisis, but this de-anchoring was
Nautz (2016) expectations? monthly) inflation expectations using a model with
temporary.
time-varying parameters
Euro Area, Expectations appear to be best anchored in the

Strohsal and Are long-term inflation Sweden, United Estimation of a market-perceived inflation Euro Area, followed by the United States,
Winkelmann expectations well Kingdom, and target using an exponential smooth transition Sweden, and the United Kingdom. In most of
(2015) anchored? United States autoregressive (ESTAR) model these countries, the degree of anchoring did not
(2004-11, daily) change during the global financial crisis.

CHAPTER 4
237
TABLE A.4.2.2 Studies on EMDEs (some including advanced economies) 238
Economies
and frequency)
CHAPTER 4
Baskaya, Inflation expectations are more sensitive to

Are inflation expectations Turkey (2006-12, Regression of inflation expectations on the lagged
Gulsen, and inflation realization at higher levels, but this
well anchored in Turkey? monthly) inflation rate
Kara (2012) sensitivity has decreased over time.
Capistrán Does inflation targeting 12 advanced Inflation targeting affects inflation expectations
Regression of dispersion of inflation expectations
and Ramos- affect inflation economies and 13 only in EMDEs. There is no effect of inflation
expectations? on a dummy for inflation targeting, the actual
Francia EMDEs (1989- targeting on the dispersion of inflation
inflation rate, and world average inflation
(2010) 2006, monthly) expectations in advanced economies.
Tests whether inflation expectations follow a

Does inflation targeting normal distribution under inflation targeting using
Carrasco and anchor inflation the Shapiro-Wilk test, Jarque-Bera test, and
Mexico (2004-11, Inflation expectations are anchored to the
Ferreiro expectations? Doornik-Hansen test. If the inflation expectations
monthly) inflation target.
(2013) are anchored, they are assumed to follow a
normal distribution where the mean is the inflation
target and the variance is constant.
Does inflation targeting

anchor inflation
Recursive OLS regression of inflation The adoption of inflation targeting helped
expectations? Is the
Cerisola and Brazil (2000-04, expectations on inflation target, lagged inflation anchor expectations; the stance of fiscal
inflation targeting
Gelos (2009) monthly) rate, primary balance as a percent of GDP, and policy was important in shaping inflation
framework supported by
other control variables expectations.
the perceived sustainability
of public finances?
Using VARs, estimation of impulse responses of During 2011-16, inflation expectations reacted
How does the loss of
Cortes and Brazil (2004-16, inflation expectation to actual inflation, exchange more strongly to actual inflation, exchange rate
credibility affect inflation
Paiva (2017) monthly) rate movements, and output gap with two movements, and output shocks than during
expectations?
subsamples: 2004-10 and 2011-16 2004-10.
TABLE A.4.2.2 Studies on EMDEs (some including advanced economies) (continued)
Economies
and frequency)
14 advanced
The introduction of inflation targeting is associated with a
Does inflation targeting economies and SVAR to test whether 12-month-ahead
statistically significant reduction in the response of short-
Davis (2014) anchor long-term 22 EMDEs inflation expectations respond to shocks to
term inflation expectations to shocks in oil prices and
inflation expectations? (1990-2011, inflation and oil prices
observed inflation.
monthly)
How does central bank Estimation of backward-looking, forward-
de Mendonça transparency affect the looking, and hybrid New Keynesian Phillips Given the degree of central bank transparency, the forward
Brazil (2001-10,
and Galveas central bank’s curves (regression of actual inflation on -looking and hybrid specifications of the Phillips curve are
monthly)
(2013) commitment to inflation inflation expectations, past inflation, and more suitable for explaining current inflation.
targeting? other control variables)
Regression of the deviation between

de Mendonça Are fiscal imbalances a Brazil
inflation and its target on the net public The deviation of realized inflation from target inflation tends
and Veiga constraint to monetary (1999-2010,
debt-to-GDP ratio and other control to be higher when the public debt-to-GDP ratio is larger.
(2014) policy? monthly)
variables
Are long-term inflation Brazil, Chile, and Long-term inflation expectations have become better
De Pooter et Test for anchoring by regression of
expectations in EMDEs Mexico (2000s- anchored during the decade to 2013, especially in Chile
al. (2014) changes in inflation expectations on news
well anchored? 2013, daily) and Mexico.
Facts about four measures of inflation
How has the extent of anchoring: absolute deviation of the The degree of anchoring of inflation expectations has
19 EMDEs
anchoring of inflation three-year-ahead inflation forecast from improved significantly over the past two decades.
IMF (2018) (2004-17,
expectations evolved in target, variability of inflation However, there is heterogeneity in the extent of anchoring
biannual)
recent decades? forecasts,dispersion of inflation forecasts, across emerging markets.
and sensitivity to inflation surprises
The inflation expectations of price setters (businesses and
Are long-term inflation unions) are higher than the upper bound of the official
Kabundi, South Africa Estimation of a market-perceived inflation
CHAPTER 4
expectations of target band, while the expectations of professional

Schaling, and (2000-13, target of individual agents using panel
individual agents well forecasters are within the target band. In addition, price
Some (2015) quarterly) regression with dummy variables
anchored? setters’ expectations are associated with lagged inflation
but analysts’ expectations are not.
239
TABLE 4.2.2 Studies on EMDEs (some including advanced economies) (continued) 240
Economies
(sample
period and
frequency)
Do consumers and
CHAPTER 4
professional
China
Lei, Lu, and forecasters update their Regression of inflation expectations on news The news media can have a strong influence on inflation
(2001-12,
Zhang (2015) inflation forecasts with about prices expectations.
quarterly)
information from the
news media?
23 advanced
Estimation of the decay function such that
Mehrotra and Are long-term inflation economies and Inflation expectations have become more tightly anchored
inflation forecasts monotonically diverge from
Yetman expectations well 21 EMDEs over time in both inflation targeting economies and in
a long-run anchor toward actual inflation as
(forthcoming) anchored? (2005-12, those following other monetary policy regimes.
the forecast horizon shortens
monthly)
In Brazil, actual inflation was above the upper limit of the

tolerance interval in 2001 and 2002 after the introduction
Does inflation targeting Brazil Regression of inflation expectations on
Minella et al. of inflation targeting in 1999. Inflation expectations react
anchor inflation (2000-03, inflation target, lagged inflation rate,
(2003) significantly to the inflation target and past inflation. The
expectations? monthly) exchange rate, and other control variables
inflation targeting regime has been successful in helping
to anchor expectations.
South Africa
Are long-term inflation Estimation of the decay function such that Inflation expectations of businesses and trade unions are
Miyajima and (2001-17,
expectations of inflation forecasts monotonically diverge from anchored to levels above the official target range although
Yetman quarterly;
individual agents well a long-run anchor toward actual inflation as overall, inflation expectations have become more strongly
(2018) 1993-2017,
anchored? the forecast horizon shortens anchored in South Africa in recent years.
monthly)
Regression of inflation expectations on
What are the India
Patra and lagged inflation, changes in prices of fuel and Lagged inflation and movements in fuel and food prices
determinants of (1997-2008,
Ray (2010) primary articles, the output gap, and real affect inflation expectations.
inflation expectations? monthly)
interest rate
Are long-term inflation South Africa Test for anchoring by regression of changes
Inflation expectations are well anchored in South Africa
Reid (2009) expectations well (2001-07, in inflation expectations on macroeconomic
due to the inflation targeting framework.
anchored? quarterly) news


Methodology
Panel regressions
If long-term expectations are well-anchored, they will not be highly responsive
to macroeconomic news. Figure 4.4, panel A, presents the results of a panel
regression model that estimates the sensitivity of changes in long-term inflation
expectations to macroeconomic news shocks. The change in long-term inflation
expectations (dependent variable) is measured by the difference between five-
year-ahead inflation expectations in the current period and five-year-ahead
inflation expectations in the previous period. The macroeconomic news shock
corresponds to an inflation shock (a regressor) that is measured by the difference
between realized inflation and short-term inflation expectations in the previous
period.1
The model includes an interaction dummy variable to allow for different
elasticities of inflation expectations in advanced economies and EMDEs:
Et πi,t+5 - Et-1 πi,t+5 = β 1(πi,t - Et-1 πi,t) + β 2Di (πi,t - Et-1 πi,t)+μi + τt +εi,t (1)
where i denotes country and t refers to time. Et πi,t+5 and Et-1 πi,t+5 are five-year-
ahead inflation expectations in the current and previous periods, respectively.
πi,t refers to realized inflation and Et-1 πi,t is short-term inflation expectations in
the previous period. Di is a dummy variable that is equal to 0 for advanced
economies and 1 for EMDEs, implying that β 1 and (β 1+ β 2) are the estimated
sensitivities for advanced economies and EMDEs, respectively. When the
estimated sensitivity is small (that is, β 1 is not statistically significantly different
from zero), inflation expectations are well anchored. The model includes
country fixed effects (μi) and time fixed effects (τt) that are estimated for three
periods: 1990H2-2004H2, 2005H1-18H1, and 1990H2-2018H1.2
Regressions with time-varying parameters:
Country-specific models
Figure 4.4, panels B, C, and D, presents the results of a time-varying model,
estimated using a Kalman filter, that captures the time variation in the sensitivity
of changes in long-term inflation expectations to inflation shocks. The model is
a version of model (1), but it includes time-varying coefficients:
1 The model follows Beechey, Johannsen, and Levin (2011); Gürkaynak, Levin, and Swanson (2010);
and De Pooter et al. (2014).

2 Because there are no available data for most EMDEs in the early 1990s, the panel data set is
unbalanced. The sample was split at 2004 to produce two samples of roughly equal length.
2
Etπt+5 - Et-1 πt+5 = α t + βt (πt - Et-1 πt) + εt ,εt ~ iid N(0,σε) (2)
where the measures of expected and realized inflation are the same as those in
model (1). The model is estimated for each of the 24 advanced economies and
23 EMDEs in the sample, using semiannual data for 1990H1-2018H1 and
1995H1-2018H1, respectively. The time-varying parameters are assumed to
follow a random walk:3
2
α t = α t-1 + ξt ,ξt ~ iid N(0,σξ )
2
βt = β t-1 + ηt ,ηt ~ iid N(0,ση )
where αt captures changes in long-term inflation expectations that are

independent of inflation shocks, and β t measures the sensitivity of inflation
expectations to inflation shocks.4 In other words, αt and β t are assumed to be
the sensitivity to the permanent and temporary shocks, respectively. If forecasters
believe that the central bank’s monetary policy is credible, they do not react to
inflation shocks. This implies that if β t is not statistically significantly different
from zero, inflation expectations are well anchored.
Regressions with time-varying parameters:

Global and domestic shocks
A simple regression model with time-varying parameters is estimated to analyze

the sensitivity of inflation expectations to global and domestic inflation shocks.
The results are presented in Figure 4.5. The global inflation shock is defined as
the first principal component of inflation shocks for the full sample of 24
advanced economies for 1990H2-2018H1 and 23 EMDEs for 1995H1-
2018H1. The domestic inflation shock is defined as the residual from a
regression of the inflation shock on the first principal component of inflation
shocks, as in the following model:
πt - Et πt-1 = δt ft + ϵt (3)
where ft is the first principal component of inflation shocks and δt is the time-
varying parameter. δt ft represents the global inflation shock and the remaining
term ϵt is defined as the domestic inflation shock. The sensitivity of five-year-
ahead inflation expectations to global and domestic inflation shocks is then
modeled as:
3 IMF (2016) and Buono and Formai (2018) also estimate models with the time-varying parameters.
IMF (2016) also uses a Kalman filter model but does not include other factors (αt). Buono and Formai
(2018) estimate their model over a rolling window in which the sample periods change over time.
4 The results remain robust when α is not included in the model.
t
Et πt+5 - Et-1 πt+5 = α t + β1t Gt + β2t Dt + εt (4)
where Gt (= δt ft) is the global shock and Dt(= ϵt) is the domestic shock. Models
(3) and (4) are estimated using a Kalman filter and with the assumption that the
time-varying parameters follow a random walk.
Panel cointegration regressions
The determinants of the degree of anchoring of inflation expectations are

studied using a set of panel regression models. The results of these exercises,
using annual data for 24 advanced economies and 23 EMDEs for 1995-2016,
are presented in Figure 4.6. The degree of anchoring is measured as the
sensitivity (β t) of changes in long-term inflation expectations to inflation shocks
(as estimated in model (2) above). Six determinants are considered: the presence
of an inflation targeting regime, the degree of central bank transparency, the
exchange rate regime, financial openness, trade openness, and the degree of fiscal
sustainability. Inflation targeting regime and fixed exchange rate regime are
dummy variables for which the presence of the indicated regime equals one.
Exchange rate regime is determined using Shambaugh (2004). Central bank
transparency and financial openness (capital account openness) are measured
using indexes produced by Dincer and Eichengreen (2014) and Chinn and Ito
(2017), respectively. Trade openness is measured as imports divided by domestic
demand (domestic demand is defined as gross domestic product (GDP) +
imports - exports). Fiscal sustainability is measured as the ratio of gross public
debt to GDP.
The empirical exercise is undertaken in four steps. First, all variables are tested in
a panel setting for unit roots.5 Some tests do not reject the null hypothesis of
nonstationarity of trade openness and gross public debt-to-GDP ratio (Table
A.4.4.2). Second, since some variables (including the inflation targeting dummy,
fixed exchange rate regime dummy, and financial openness index) are stationary,
residual series are obtained from a panel regression of sensitivity of inflation
expectations on these stationary variables. Specifically, the following model is
estimated:
β i,t = Ѳ i + φ t + γMPi,t + δXi,t + ϵi,t (5)
where β i,t is the time-varying estimate of the country-specific estimate of the

elasticity of inflation expectations to inflation shocks, as explained in the
5 This test follows Im, Pesaran, and Shin (2003); Maddala and Wu (1999); and Choi (2001).
Although the time-varying parameters are constructed under the assumption of a random walk, most
results of panel unit root tests reject the null hypothesis of nonstationarity.
discussion of regressions with time-varying parameters. MPi,t is (i) a dummy

variable that takes a value of one in countries with an inflation targeting
framework or (ii) a measure of central bank transparency. Xi,t includes a dummy
variable that takes a value of one for countries with a fixed exchange rate regime
and financial openness index. Ѳ i captures country-fixed effects and φ t refers to
time fixed effects.
Third, the existence of cointegration between the residuals from the panel
regression in model (5) and the gross public debt-to-GDP ratio and trade
openness is tested by employing Pedroni’s (1999) cointegration test
(Table A.4.4.3). The results indicate that the residuals are cointegrated with the
two variables. Fourth, following Pedroni (2000, 2001), a grouped mean fully
modified ordinary least squares (FMOLS) regression model and a grouped mean
dynamic OLS (DOLS) regression model are estimated to correct for endogeneity
bias and serial correlation. The dependent variable is the estimated residual
from the panel regression in model (5). The independent variables are trade
openness (measured by the import penetration ratio) and the gross public debt-
to-GDP ratio.
Database
TABLE A.4.3.1 List of countries
Country group Countries
Australia, Austria, Belgium, Canada, Denmark, Finland, France,

Germany, Greece, Ireland, Israel, Italy, Japan, Korea, the
Advanced economies (24)
Netherlands, New Zealand, Norway, Portugal, Singapore, Spain,
Sweden, Switzerland, the United Kingdom, the United States
Argentina, Bangladesh, Brazil, Chile, China, Colombia, the Arab

Republic of Egypt, India, Indonesia, the Islamic Republic of Iran,
EMDEs (23) Kuwait, Malaysia, Mexico, Pakistan, Peru, Poland, the Russian
Federation, Saudi Arabia, South Africa, Thailand, Tunisia, Turkey,
Zambia
Note: The numbers in parentheses are the number of countries in the sample. EMDEs = emerging market and developing
economies.
TABLE A.4.3.2 Description of the variables

Variable Description Sources
Current year, one-year-ahead, five-year-
ahead inflation forecasts based on surveys
Inflation expectations
conducted biannually for 30 countries by
(advanced Consensus Economics,
Consensus Economics, complemented by
economies: 1990H1- Consensus Forecast;
current year, one-year-ahead, and
2018H1 IMF, World Economic
five-year-ahead annual average headline
EMDEs: 1995H1- Outlook database
CPI inflation forecasts produced biannually
2018H1)
for 17 countries in the IMF's World
Economic Outlook database.
IMF, Annual Report on
Inflation targeting A dummy variable equal to 1 for inflation
Exchange Arrangements
regime targeting regime and 0 for no inflation
and Exchange Restrictions
(1995-2016) targeting regime.
database
Index calculated from responses to 15

Central bank
questions. To expand the sample, the Dincer and Eichengreen
transparency
index was extrapolated to 2015-16 using (2014)
(1995-2014)
2014 data.
The exchange rate regime classification

developed in Shambaugh (2004) is used to
Exchange rate regime determine whether a country has a pegged
Shambaugh (2004)
(1995-2014) or flexible exchange rate. To expand the
sample, the index was extrapolated to
2015-16 using 2014 data.
Index of de jure capital account openness.

Financial openness
To expand the sample, the index was Chinn and Ito (2017)
(1995-2015)
extrapolated to 2016 using 2015 data.
Imports divided by domestic demand

Trade openness IMF, International Financial
(domestic demand = GDP + imports -
(1995-2016) Statistics database
exports).
Gross public debt IMF, World Economic
Gross public debt divided by nominal GDP.
(1995-2016) Outlook database
Oil prices World Bank, Commodity

Index is in nominal U.S. dollars.
(1990H1-2017H2) Price Data (the Pink Sheet)
Food prices World Bank, Commodity

Index is in nominal U.S. dollars.
(1990H1-2017H2) Price Data (the Pink Sheet)
Bank for International

Global liquidity International claims on all sectors (annual
Settlements, Global Liquidity
(1990H1-2017H2) change).
Indicators database
Real GDP-weighted average of country
Global output gap
specific output gaps estimated using a World Bank (2018)
(1990H1-2017H2)
multivariate filter.
Note: CPI = consumer price index; EMDEs = emerging market and developing economies; IMF = International Monetary
Fund.
ANNEX 4.4 Estimation results

TABLE A.4.4.1 Sensitivity of long-term inflation expectations to
inflation shocks
A. 1990H2-2018H1
Dependent variable: Change in long-term inflation expectations
Advanced
All countries All countries EMDEs
economies
0.282***
All countries
(0.021)
Advanced 0.159*** 0.154***
economies (0.028) (0.032)
0.425*** 0.425***
EMDEs
(0.030) (0.030)
Observations 2,408 2,408 1,344 1,064
R-squared 0.069 0.086 0.019 0.169
B. 1995H1-2004H2
Advanced
economies
0.423***
All countries
(0.035)
Advanced 0.284*** 0.278***
economies (0.049) (0.052)
0.554*** 0.558***
EMDEs
(0.048) (0.046)
Observations 1,139 1,139 696 443
R-squared 0.119 0.131 0.044 0.261
C. 2005H1-2018H1
Advanced
economies
All countries 0.083***
Advanced 0.008 -0.001
economies (0.028) (0.031)
0.201*** 0.206***
EMDEs
(0.034) (0.037)
Observations 1,269 1,269 648 621
R-squared 0.011 0.028 0.000 0.049
Note: Standard errors are in parentheses. EMDEs = emerging market and developing economies.
A.-C. Results for the full sample of 47 countries, 24 advanced economies, and 23 EMDEs, with country and time fixed
effects.
*** p < 0.01, ** p < 0.05, * p <0.1 significance level.
TABLE A.4.4.2 Panel unit root tests

A. All countries
Intercept and trend Intercept
Im-Pesaran- ADF Im-Pesaran- ADF
PP Fisher PP Fisher
Shin Fisher Shin Fisher
Total -23.1 1167.2 560.8 -15.2 853.4 444.3
sensitivity (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)***
Gross public 0.0 102.0 42.9 -4.9 405.2 78.2
debt (0.52) (0.27) (1.00) (0.00)*** (0.00)*** (0.88)
-2.2 145.3 112.2 -0.9 96.1 89.2
Penetration
(0.01)*** (0.00)*** (0.10)* (0.19) (0.42) (0.62)
B. Advanced economies
PP Fisher PP Fisher
Total -3.7 96.7 95.2 -0.4 71.8 98.4
sensitivity (0.00)*** (0.00)*** (0.00)*** (0.34) (0.01)*** (0.00)***
Gross public 1.1 38.2 14.2 -0.6 55.8 27.9
debt (0.86) (0.84) (1.00) (0.26) (0.21) (0.99)
-3.4 86.3 53.3 -0.9 49.3 47.2
Penetration
(0.00)*** (0.00)*** (0.28) (0.18) (0.42) (0.50)
C. EMDEs
PP Fisher PP Fisher
Total -29.1 1070.5 465.6 -21.3 781.6 345.9
sensitivity (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)***
Gross public -1.0 63.8 28.6 -6.4 349.5 50.3
debt (0.16) (0.04)** (0.98) (0.00)*** (0.00)*** (0.31)
1.0 48.2 60.5 0.1 43.9 43.8
Penetration
(0.85) (0.38) (0.07)* (0.53) (0.56) (0.56)
Note: P-values are in parentheses. ADF = augmented Dickey-Fuller unit-root test; EMDEs = emerging market and
developing economies; PP = Phillips-Perron unit-root test.
A. Results for the full sample of 47 countries, using data for 1995-2016.
B. Results for 24 advanced economies, using data for 1995-2016.
C. Results for 23 EMDEs, using data for 1995-2016.
The null hypothesis of a unit root is rejected at significance levels of *** p < 0.01, ** p < 0.05, * p < 0.1.
TABLE A.4.4.3 Panel cointegration tests

Intercept and trend
All countries Advanced economies EMDEs
Statistic p-value Statistic p-value Statistic p-value

Panel v-statistic -1.7 0.96 2.0 0.03** -1.2 0.88
Panel rho-statistic -9.7 0.00*** 1.0 0.84 -7.0 0.00***
Panel PP-statistic -27.8 0.00*** -3.0 0.00*** -19.5 0.00***
Panel ADF-statistic -22.4 0.00*** -3.8 0.00*** -15.7 0.00***
Group rho-statistic 0.3 0.60 3.1 1.00 -0.5 0.30
Group PP-statistic -13.9 0.00*** -0.9 0.18 -10.8 0.00***
Group ADF-statistic -11.7 0.00*** -2.7 0.00*** -10.7 0.00***
Intercept
All countries Advanced economies EMDEs
Statistic p-value Statistic p-value Statistic p-value

Panel v-statistic 2.4 0.01*** -0.5 0.69 1.9 0.03**
Panel rho-statistic -11.5 0.00*** -0.2 0.42 -8.3 0.00***
Panel PP-statistic -19.4 0.00*** -2.8 0.00*** -13.8 0.00***
Panel ADF-statistic -15.2 0.00*** -2.7 0.00*** -11.0 0.00***
Group rho-statistic -1.3 0.09* 1.9 0.97 -1.1 0.14
Group PP-statistic -10.0 0.00*** -1.6 0.06* -7.0 0.00***
Group ADF-statistic -9.5 0.00*** -2.9 0.00*** -8.7 0.00***
Note: Results for the full sample of 47 economies, 24 advanced economies, and 23 EMDEs, all using data for 1995-2016.
ADF = augmented Dickey-Fuller unit-root test; EMDEs = emerging market and developing economies; PP = Phillips-Perron
unit-root test.
The null hypothesis of no cointegration is rejected at significance levels of *** p < 0.01, ** p < 0.05, * p < 0.1.
TABLE A.4.4.4 Determinants of sensitivity of inflation expectations
A. Panel regressions
Dependent variable: Estimated sensitivity
All All Advanced Advanced
EMDEs EMDEs
countries countries economies economies
Model FE FE FE FE FE FE
-0.390*** -0.222*** -0.498***
Inflation targeting
(0.094) (0.053) (0.165)
Central bank -0.414** 0.040 -0.724*

transparency (0.204) (0.108) (0.377)
Exchange rate 0.306** 0.307** 0.255 0.012 0.060 0.079
regime (0.147) (0.149) (0.395) (0.405) (0.222) (0.224)
0.141 0.046 0.032 -0.094 -0.059 -0.186
Financial openness
(0.178) (0.177) (0.121) (0.125) (0.289) (0.286)
Exchange rate 0.070 -0.046 -0.343 -0.069 1.037** 1.001**
regime x financial
openness (0.222) (0.225) (0.400) (0.410) (0.490) (0.493)
Observations 1,034 1,034 528 528 506 506
R-squared 0.067 0.055 0.203 0.178 0.078 0.067
Note: Results of panel regressions for the full sample of 47 countries, 24 advanced economies, and 23 EMDEs, with coun-
try and time fixed effects, using data for 1995-2016. Standard errors are in parentheses. EMDEs = emerging market and
developing economies; FE = fixed effects.
*** p < 0.01, ** p < 0.05, * p < 0.1 significance level.
B. Panel cointegration regressions (fully modified OLS and

dynamic OLS)
Dependent variable: Residual from the first regression
All All Advanced Advanced
EMDEs EMDEs
countries countries economies economies
Model FMOLS DOLS FMOLS DOLS FMOLS DOLS
-0.004 -0.010 0.012 0.010 -0.015 -0.021
Penetration
(0.004) (0.010) (0.003)*** (0.006)* (0.008)** (0.011)*
0.008 0.009 -0.002 -0.001 0.018 0.020
Gross public debt
(0.002)*** (0.003)*** (0.001)*** (0.001) (0.005)*** (0.006)***
Note: Results of group mean panel fully modified ordinary least squares regressions (FMOLS) and group mean dynamic
ordinary least squares regressions (DOLS) the full sample of 47 countries, 24 advanced economies, and 23 EMDEs.
Standard errors in parentheses. DOLS = dynamic ordinary least squares; EMDEs = emerging market and developing
economies; FMOLS = fully modified ordinary least squares; OLS = ordinary least squares.
*** p < 0.01, ** p < 0.05, * p < 0.1 significance level.
ANNEX 4.5 Inflation targeting: Country experiences

Inflation targeting in Brazil
Rationale. Brazil adopted inflation targeting in July 1999 after it became clear
that five years of exchange rate targeting had failed. Despite the success of the
Central Bank of Brazil (BCB) in reducing historically high inflation through
exchange rate stabilization measures, which began in 1994, a lack of fiscal
discipline resulted in a gradual buildup of government debt, which in turn made
the Brazilian real vulnerable to speculative attacks (Mishkin and Savastano
2002). Amid a severe currency crisis that began in early 1999, Brazil shifted to
an inflation targeting regime to “coordinate market expectations and control
inflation” (Barbosa-Filho 2008).
Process. The inflation targeting framework, adopted by presidential decree,

established that the National Monetary Council would set inflation targets no
later than two years in advance, following a transition period concluding in
2002. The BCB was granted instrument independence to this end (Bognanski,
Tombini, and Werlang 2000). If end-year annual inflation is out of the
established tolerance range, which has been changed over time, the governor of
the BCB is required to provide an open (public) letter to the minister of finance
explaining why the target was not met and what actions will be taken to return
inflation to the target range. The framework also required the BCB to issue a
quarterly inflation report detailing the results of its recent monetary policy
actions and its projections for inflation.
Several aspects of Brazil’s inflation targeting framework are distinctive. For one,
the BCB is not solely responsible for setting the inflation target range. The entity
that establishes the targets, the National Monetary Council, is composed of the
governor of the BCB, the minister of finance, and the minister of planning,
development, and management. In addition, Brazil’s target band was for a long
time quite wide compared to that in other inflation targeting countries (IMF
2015).1 Official assessment of whether the annual target has been met is based
only on the December/December change in the consumer price index (CPI).
Furthermore, although Brazil has maintained a de jure flexible exchange rate
under its inflation targeting regime, the BCB has at times intervened in foreign
exchange markets to manage excess volatility of the currency.
1 However, after the target was held at 4.5 percent and the tolerance band at 2.5-6.5 percent since
2006, the band was narrowed to 3-6 percent in 2018. Over 2019-21 the target and tolerance band will be
incrementally lowered on an annual basis, to a target of 3.75 percent within a band of 2.25-5.25 percent
in 2021.
When inflation targeting was adopted in 1999, Brazil had a sound banking
system and was in the process of strengthening its fiscal profile. The banking
system had been restructured after a crisis in the early 1990s. Although
government debt was still rising in 1999, fiscal adjustment was underway. A
series of debt restructuring agreements between individual states and the federal
government had been negotiated a few years prior. Fiscal discipline improved
with the passing of the Fiscal Responsibility Law in 2000 (López Vicente and
Serena Garralda 2014).
Results. Brazil’s inflation targeting regime was successful in the first years after
its inception. Inflation was within the target range in 1999 and 2000, and BCB
transparency improved markedly (Figure A.4.5.1). A major challenge developed
in 2001, however, when a combination of shocks—a severe drought and energy
crisis, slowing global growth, and contagion from a financial crisis in
Argentina—led to another bout of currency depreciation (Minella et al. 2003).
The currency pressure was exacerbated in 2002 by a sharp rise in bond spreads, a
weak external position (Brazil had insufficient capital inflows to finance its
current account deficit and foreign exchange reserves were low), and uncertainty
about macroeconomic policy during the presidential election cycle. As the real
depreciated, inflation spiked to more than 17 percent in May 2003, and
concerns about debt sustainability rose (at the time, half of Brazil’s public debt
was denominated in or indexed to the U.S. dollar). Inflation far exceeded the
upper bound of the target band for three consecutive years to 2003, and three-
year-ahead inflation expectations were around the upper limit of the target
inflation band in 2002 and 2003. Five-year-ahead expectations, however,
remained better anchored and within the band, reaching a maximum of 5.2
percent in the first half of 2003, below the 6.5 percent upper limit at the time.
The deviations from the target in 2001-03 were followed by a long period of
better performance. Although headline inflation remained above the upper limit
of the target band through mid-2005, five-year-ahead inflation expectations for
Brazil declined toward the middle of the band. However, disinflation during
these years occurred in large part due to exchange rate appreciation, which
resulted from a combination of relatively high domestic policy interest rates and
a supportive global trade and financing environment (Barbosa-Filho 2008;
Arestis, Ferrari-Filho, and de Paula 2011).
Brazil managed to keep inflation within the target band during the global
financial crisis. Headline inflation rose in the leadup to the global financial crisis
in response to rising oil prices, strong capital inflows, and growing domestic
demand, but was still within the target band as Lehman Brothers collapsed.
Inflation expectations increased in 2007 and 2008, but not sharply, providing
evidence that expectations had become better anchored under the inflation
FIGURE A.4.5.1 Inflation targeting in Brazil
Inflation in Brazil has overshot the target range significantly at times since the Central Bank
of Brazil’s adoption of inflation targeting. Although long-term inflation expectations are not
as well anchored as in some other inflation targeting EMDEs, the sensitivity of inflation to
shocks has been permanently lower and remarkably constant following a large initial drop
after the introduction of inflation targeting.
A. Actual inflation and inflation expectations B. Central bank transparency
C. General government primary balance and D. Sensitivity of inflation expectations to

gross debt shocks
Source: Consensus Economics; Dincer and Eichengreen 2014; Haver Analytics; International Monetary Fund; World Bank.
A.B.D. The start of the inflation targeting regime is shaded in gray.
B. Transparency is based on information from the Central Bank of Brazil’s website, statutes, annual reports, and other
published documents, as calculated by Dincer and Eichengreen (2014).
C. The primary balance is net government lending and borrowing, excluding net interest payments.
D. Time-varying sensitivity is estimated by regressing long-term inflation forecast revisions on inflation shocks. Dotted lines
denote the 68 percent confidence interval. Annex 4.3. provides details on the methodology.
targeting regime. As the crisis deepened and capital inflows dropped sharply,
BCB prioritized stabilizing the exchange rate and maintaining adequate
liquidity, in part through foreign exchange market interventions and reducing
reserve requirements (Céspedes, Chang, and Velasco 2014).
From 2011 to mid-2014, headline inflation in Brazil was near or slightly above
the upper limit of the target band, reflecting currency depreciation, rising wage
costs, continued price indexation, and, in the latter part of this period, drought
conditions in parts of the country that were aggravated by the onset of the El
Niño weather phenomenon (IMF 2015). In response, BCB began raising

interest rates in mid-2013. Yet, inflationary pressures intensified after increases
in regulated gasoline and diesel prices in late 2014 and electricity tariffs in early
2015. From mid-2014 through late 2016, headline inflation was persistently
above the upper bound of the target range, and more than 4 percentage points
above the upper bound of 6.5 percent over the 12 months ending December
2015. Moreover, the government’s primary balance deteriorated sharply, raising
the public debt-to-GDP ratio. However, despite rapidly rising inflation, five-year
-ahead inflation expectations remained firmly in the middle of the band,
suggesting that the inflation targeting regime retained credibility.
After peaking in early 2016 following the realignment of administered prices,
inflation gradually moderated, and the BCB began an extended period of
interest rate easing late in the year. By the end of 2017, inflation was slightly
below the 3 percent lower bound of the target band, largely due to food price
deflation that in turn reflected very strong agricultural production. Five-year-
ahead inflation expectations continued to moderate during this period.
The behavior of inflation expectations in Brazil has been broadly consistent with
the estimated sensitivity of long-term inflation expectations to shocks. Following
a large initial drop in the sensitivity of expectations to shocks after the
introduction of the inflation targeting regime in 1999, sensitivity has been more
or less constant, suggesting that the inflation targeting regime has been successful
in anchoring expectations. Yet the sensitivity to shocks is still higher than in
some other inflation targeting emerging market and developing economies
(EMDEs). A deterioration of fiscal balances could have impeded the anchoring
of inflation expectations (Cerisola and Gelos 2009; de Mendonça and Veiga
2014). An additional factor may have been that central bank independence was
less well established in Brazil than in other countries (Cortes and Paiva 2017;
Minella et al. 2003).
Lessons learned. Brazil’s experience with inflation targeting offers two key
lessons. First, long-term inflation expectations can remain stable during sharp
fluctuations in actual inflation even in the absence of typical elements
of inflation targeting regimes elsewhere (for example, the central bank having
sole power to set inflation targets, fixed-term appointment of central bank
governors, and use of a narrow inflation target band). Further, inflation
expectations in Brazil have been stable despite periodic questions about the
credibility of the inflation targeting regime arising from its unique institutional
arrangements (IMF 2015). However, some of the specifics of the regime (that is,
a wide target band and use of only December data for measuring results) have
arguably made formal compliance with targets easier than in most other inflation
targeting countries.
Second, fiscal policy can be a key factor in determining the outcome of inflation
targeting and controlling inflation expectations (Cerisola and Gelos 2009; de
Mendonça and Veiga 2014). For instance, during the 2001-03 currency crisis,
Brazil avoided a prolonged growth contraction thanks to the fiscal adjustments
put in place in the late 1990s. These measures lent support to the inflation
targets and the BCB’s well-articulated strategy for reverting inflation to target
levels (Giavazzi, Goldfajn, and Herrera 2005). At the same time, the structure of
public debt in Brazil at the time—a large share of debt was short term or
denominated in foreign currency—was a constraint on the central bank’s ability
to target inflation freely, since interest rate hikes abroad had a significant adverse
impact on debt service obligations. Similarly, the high level of foreign currency–
denominated debt may have also dissuaded the central bank from allowing the
exchange rate to float freely, despite the stated commitment to floating (López
Vicente and Serena Garralda 2014). Over time, the structure of public debt has
changed, and the vast majority of domestic debt is now issued domestically.
However, the stock of debt has risen rapidly in recent years.
Inflation targeting in Chile
Rationale. Expansionary macroeconomic policies in Chile in the late 1980s,

together with the oil price spike that accompanied the Gulf War in the early
1990s, resulted in a sharp increase in inflation, to a peak of 30 percent in
October 1990. These factors triggered the decision to adopt inflation targeting
(Morandé 2002). Policy makers recognized that the fundamental historical
driver of the inflation trends was excessive credit expansion by the Central Bank
of Chile (BCC) (Corbo 2005). To better discipline monetary policy, the BCC
first announced a numerical target for inflation in 1990. Since the target was set
for just one year ahead, it did not amount to the complete adoption of inflation
targeting. But it was the first step in the transition toward such a regime.
Process. Gradual implementation, a hallmark of Chile’s inflation targeting

experience, allowed the BCC to build credibility. Legislation passed in 1989
made the BCC fully independent and declared price stability to be the primary
monetary policy objective. The BCC was given authority to define this objective
(that is, goal independence) and control the instruments of monetary policy
(that is, instrument independence). Its new framework of banking sector
regulation and supervision was among the strongest of all emerging markets
(Mishkin 2004).
Starting in 1991, the BCC adopted a partial inflation targeting regime. Under
this arrangement, it announced a headline target for annual inflation in
December each year, gradually reducing the level of the target, but continued to
target an exchange rate band and retained the right to use short-term capital
controls if needed.2 Chile used unremunerated (non-interest bearing) reserve

requirements on selective capital inflows through most of the 1990s to
discourage buildups of short-term liabilities, favored a weaker exchange rate, and
provided more operating space for monetary policy (De Gregorio, Tokman, and
Valdés 2005). The exchange rate band was widened during the decade, allowing
more flexible adjustment to external shocks (Bordo and Siklos 2014).
In September 1999, Chile shifted to a floating exchange rate regime and

formally adopted a flexible inflation targeting framework that recognized the lag
effect in monetary policy and the short-run trade-off with output. Key
components of the framework included bolstering the statistical and analytical
capacity of the BCC, publication of a monetary policy report (initially three
issues per year, and four per year since 2009), and the release of minutes of
monetary policy meetings with a short lag. In addition, the BCC announced its
intent to deepen the foreign exchange derivatives market and intervene in the
foreign exchange market only in extraordinary circumstances (Valdés 2007).
Over time, Chile’s inflation target has been fine-tuned. In 1999, the BCC set
the target band for annual inflation at 2-4 percent (to be achieved in 2001) and
later extended this target indefinitely. In 2001, the target was redefined as 3
percent with at ± 1 percentage point tolerance range, and the horizon for
achieving the 3 percent target, from any current deviation, was lengthened from
12-24 months to 24 months to account more realistically for the lag in the
monetary transmission mechanism.
In 2001, the government adopted a balanced budget rule that constrained public
expenditures, to ensure that the structural balance, measured as a share of GDP,
met a specific target or range (De Gregorio 2009b; Llédo et al. 2017). The fiscal
targets are were then regularly adjusted in line with changes in potential growth
and forecasts of long-term copper prices.3 Two independent committees, one
focused on potential output and the other on copper prices, advise on the
practical calculation of the structural balance.
Results. Despite some large fluctuations of inflation around the target range,
long-term inflation expectations in Chile have been remarkably well anchored
since the adoption of inflation targeting, and the sensitivity of inflation
expectations to shocks is among the lowest in EMDEs. During the early years of
the inflation targeting regime, inflation fell and became less volatile. Even under
the partial inflation targeting regime, there was a sustained decline in headline
2The new framework also included current account deficit targets (Céspedes and Soto 2005).
3Prior to 2015, long-term molybdenum prices were also considered in setting structural balance
targets. Llédo et al. (2017) provide additional details.
FIGURE A.4.5.2 Inflation targeting in Chile
Inflation has shown wide fluctuations around the target range under Chile’s inflation
targeting regime. Yet inflation expectations have been stable, perhaps reflecting the
presence of a comprehensive, credible macroeconomic policy framework that includes the
use of a fiscal rule. The sensitivity of long-term inflation expectations in Chile to shocks has
diminished to a remarkably low level.
A. Actual inflation and inflation expectations B. Central bank transparency
C. General government structural balance and D. Sensitivity of inflation expectations to

debt shocks
Source: Bloomberg, Consensus Economics, Dincer and Eichengreen (2014), Haver Analytics, International Monetary Fund,
World Bank.
A.-D. The start of the inflation targeting regime is shaded in gray.
B. Transparency is based on information from the Central Bank of Chile’s website, statutes, annual reports, and other
C. Structural balance is the difference between government revenues and expenditures, adjusted for effects due to
economic cycles.
denote 68 percent confidence interval. Annex 4.3 provides details on the methodology.
inflation and inflation expectations (Figure A.4.5.2). Average inflation fell from
15.5 percent in 1991-94 to 5.7 percent in 1995-98. Moreover, the exchange
rate pass-through to inflation dropped significantly starting in the mid-1990s
and continued falling after the adoption of formal inflation targeting in 1999
(Schmidt-Hebbel and Tapia 2002).
A period of low inflation in 2003 and 2004 challenged the credibility of Chile’s
inflation target. In the second half of 2003, Chile experienced a significant and
unexpected deceleration in inflation, as the peso appreciated and competition in

the retail sector intensified (Central Bank of Chile 2004). Although survey-based
inflation expectations remained close to the target of 3 percent (that is, well
anchored), five-year-ahead, market-based inflation expectations declined
significantly.
Long-term inflation expectations varied only slightly during the global financial
crisis, despite large gyrations in actual inflation. From mid-2007 to late 2008,
headline inflation in Chile experienced upward pressure from international
factors—namely, rising food and energy prices. Headline inflation peaked at 9.9
percent (year-on-year) in October 2008. Although short-term expectations
increased significantly as inflation rose, the reaction of five-year-ahead
expectations was much more muted, reaching a high of 3.2 percent in the
second half of 2008. Thereafter, as the global financial crisis deepened and
global activity slowed, inflation in Chile rapidly became negative, prompting a
775 basis point reduction in the policy interest rate in the seven months to July
2009 and the introduction of several liquidity support measures. Yet five-year-
ahead inflation expectations dropped only slightly, to 2.9 percent in the second
half of 2009, suggesting that expectations were by that point very well anchored.
Inflation rose well above the target band in 2014-16, due to peso depreciation
following the slump in copper prices. However, excess capacity in the economy
and a cautious monetary policy stance helped reduce inflationary pressure,
and by mid-2017, inflation began to slightly undershoot the target band. Food
price deceleration and, initially, peso appreciation, contributed to the
undershooting. Through these fluctuations, long-term inflation expectations
were impressively stable.
Indeed, inflation expectations at the three-year-ahead and five-year-ahead

horizons have been stable at around 3 percent since 1999. At the same time, the
sensitivity of long-term inflation expectations to revisions in the short-term
inflation forecast and other factors steadily declined during the decade after the
adoption of full-fledged inflation targeting. Since 2009, the sensitivity of long-
term expectations to shocks has been close to zero, consistent with findings by
De Pooter et al. (2014) that inflation expectations have become better anchored
in Chile over time.
Lessons learned. Chile’s experience with inflation targeting offers three key
lessons. First, gradual and successful implementation of the regime can have a
lasting impact on inflation expectations. Second, deviations of actual inflation
from the target, although substantial at times in Chile’s case, need not weaken
the credibility of the central bank. A clear strategy for returning inflation to
target during the medium term, taking into account the lagged effect of
monetary policy and the short-run trade-off between output and inflation, is
more important than precise targeting from one year to the next. Third, a
comprehensive, credible macroeconomic policy framework has yielded positive
returns in Chile. A credible fiscal rule, strong financial sector regulation and
supervision, and well-functioning capital markets—as well as the monetary
policy regime of inflation targeting with a flexible exchange rate—have all
helped generate favorable macroeconomic outcomes (De Gregorio, Tokman,
and Valdés 2005; Valdés 2007).
Inflation targeting in Poland
Rationale. During the 1990s, monetary policy in Poland embodied two

intermediate strategies: maintaining a stable exchange rate and controlling
money supply growth (NBP 1998). Amid the challenges related to the transition
to a market economy, inflation was reduced from an extremely high level in
1990 to around 10 percent by the end of the decade. But the two strategies also
generated tension in the conduct of monetary policy. Inflation stabilization
stalled, while episodes of excessive capital inflows, as Poland integrated more
deeply into global markets, stoked fears of inflation persistence. Growing current
account deficits highlighted a primary disadvantage of exchange rate targeting,
since a flexible rate offers a key adjustment mechanism for balance of payments
disequilibria. Coupled with the need to meet certain price stability and exchange
rate criteria as Poland began accession discussions with the European Union
(EU), this triggered the announcement by the National Bank of Poland (NBP)
in 1998 that it would adopt an inflation target beginning in 1999 (Gottschalk
and Moore 2001; Jonas and Mishkin 2003).
Process. Major legislative changes in the late 1990s paved the way for the
adoption of inflation targeting. A new constitution in early 1997, together with
the Act on the National Bank of Poland passed later the same year, established
goal and instrument independence for the NBP (Polański 2004). Monetary
policy would henceforth be conducted by a Monetary Policy Council composed
of 10 members serving fixed-duration terms. The new constitution also
enshrined two Maastricht Treaty fiscal requirements into law: it barred direct
NBP financing of government deficits and imposed a public debt ceiling of 60
percent of GDP.4 These legislative changes followed the development of indirect
instruments of monetary policy in the early 1990s, including Treasury bills and
bonds, which allowed the NBP to begin to conduct open market operations.
4 However, the risk of fiscal dominance over monetary policy was perceived to be already low at the
time (Gottschalk and Moore 2001).

Introducing the medium-term strategy for inflation targeting, the Monetary

Policy Council committed to achieving inflation-reduction targets and
publishing a semi-annual inflation report (NBP 1998). The medium-term target
for CPI inflation was defined as below 4 percent by 2003. By the end of 2002,
inflation was less than 2 percent, well below the target ceiling. Poland took a
cautious approach to liberalizing its exchange rate, indicating that the date of
floating would depend on foreign exchange market developments and the pace
of capital account liberalization. The eventual flotation of the zloty in April
2000 was smooth, however, with no speculative attack despite a large current
account deficit.
Over time, Poland’s inflation targeting regime has been fine-tuned. In 2003, the
NBP redefined the target to be 2.5 percent, within a band of ± 1 percentage
point (NBP 2003).
Results. When inflation targeting was announced in 1998, inflation was falling.
Yet, the short-term inflation target was still overshot in 1999-2001, even after
the target band was raised and widened in 2001 (Figure A.4.5.3). This was
followed by four years of below-target inflation. Several factors may explain the
undershooting of inflation relative to the target. First, the immature domestic
bond market limited the ability of the NBP to estimate the transmission of
monetary policy to inflation (Christoffersen, Slok, and Wescott 2001; Polański
2004). Second, deficiencies in data availability and quality prevented timely
identification of inflation pressures, and excess liquidity produced by foreign
exchange intervention and institutional issues in the banking sector distorted
monetary policy transmission (Schaechter, Stone, and Zelmer 2000). Despite
the misses, the NBP communicated the deviations sufficiently far in advance
that the public was not surprised by them (Buliř et al. 2008). The avoidance of
surprises helped build the credibility of inflation targeting.
Inflation overshot the target band during and after the global financial crisis but
persistently undershot it in 2013-16. In 2013, the slowdown of the Euro Area
led to region-wide disinflation, including in Poland, where inflation fell below
target. The plunge in oil prices that began in mid-2014 accelerated the
deflationary trend, contributing to negative inflation during 2014-16. However,
the impact of low inflation in the Euro Area on the Polish economy was smaller
than in economies with more rigid exchange rate regimes (Iossifov and Podpiera
2014). During the period of undershooting, the NBP kept its policy rate at 1.5
percent amid concerns about macroeconomic stability (NBP 2016). Inflation
recovered to the target range in 2017, as oil prices rose and the Euro Area
economy strengthened.
Measures of long-term inflation expectations in Poland have stabilized under the

inflation targeting regime, mostly fluctuating within the target band. Five-year-
FIGURE A.4.5.3 Inflation targeting in Poland
After the introduction of inflation targeting in Poland, inflation converged toward the target
range, long-term inflation expectations became better anchored, and a measure of central
bank transparency improved markedly. Over time, the sensitivity of inflation expectations to
shocks has declined.
A. Inflation and inflation expectations B. Central bank transparency
C. General government primary balance and D. Sensitivity of inflation expectations to

debt shocks
Source: Consensus Economics; Dincer and Eichengreen 2014; Haver Analytics; International Monetary Fund; World Bank.
A.-D. The start of the inflation targeting regime is shaded in gray.
B. Transparency is based on information from the National Bank of Poland’s website, statutes, annual reports, and other
C. The primary balance is net government lending and borrowing, excluding net interest payments.
denote the 68 percent confidence interval. Annex 4.3 provides details on the methodology.
ahead inflation expectations stabilized immediately after the shift to inflation

targeting—initially, to a level well below the target band. Since 2003, the year
the short- and medium-term targets were merged, five-year-ahead expectations
have been firmly anchored at about 3 percent. This is consistent with the low
and steadily moderating sensitivity of inflation expectations to shocks and an
improvement in monetary policy credibility (NBP 2003).
Lessons learned. Poland’s experience with inflation targeting offers two key
lessons. First, it is possible to control inflation, despite limitations on the
relevant data and the presence of much uncertainty about monetary policy
transmission. When inflation targeting was adopted in 1999, domestic financial
markets in Poland were still developing, and the transmission of monetary policy
in the emerging market economy was untested. Although these conditions
limited the NBP’s ability to respond to shocks in a timely manner, the NBP
succeeded in bringing down the inflation rate, broadly in line with the medium-
term targets. Inflation volatility as well fell significantly after the introduction of
inflation targeting.
Second, the combination of inflation targeting and a flexible exchange rate seems
to have reduced spillovers from external shocks, in line with results in the
literature on macroeconomic adjustment (for example, Georgiadis 2016). Real
exchange rate depreciation supported Poland’s growth during the global
financial crisis, even as other European economies experienced a sharp slowdown
in activity (Andrle, Garcia-Saltos, and Ho 2014). Moreover, spillovers to Poland
from the recent period of ultra-low inflation in the Euro Area were lower than in
other EU countries with lower exchange rate flexibility (for example, Bulgaria
and Croatia) (Iossifov and Podpiera 2014).
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CHAPTER 5
Inflation and Exchange Rate Pass-Through
The degree to which domestic prices adjust to exchange rate movements is key to
understanding inflation dynamics, and hence to guiding monetary policy decisions.
However, the exchange rate pass-through to inflation varies considerably across
countries and over time. This chapter brings to light two fundamental factors
accounting for these variations: the nature of the shock triggering currency
movements and country-specific characteristics. First, an empirical investigation
demonstrates that different domestic and global shocks can be associated with widely
different pass-through ratios. This underscores the need to consider the underlying
causes of currency movements before evaluating their impact on inflation. Second,
country characteristics matter, including policy frameworks that govern monetary
policy responses, as well as other structural features that affect an economy’s sensitivity
to currency fluctuations. Pass-through ratios tend to be lower in countries that
combine flexible exchange rate regimes and credible inflation targets. The empirical
results also suggest that central bank independence can greatly facilitate the task of
stabilizing inflation following large currency movements and allows fuller use of the
exchange rate as a buffer against external shocks.
Introduction
Exchange rate fluctuations are an important driver of inflation and could
therefore have significant implications for the formulation of monetary policy
(Fischer 2015; Forbes 2015; Mishkin 2008). The expected impact of currency
movements on consumer prices will determine how the central bank should
react to them. In particular, monetary authorities might look beyond the price-
level effect of an exchange rate movement but may choose to respond if the
impact on inflation is persistent. The risk of policy missteps if the pass-through
is not properly evaluated is particularly elevated in emerging market and
developing economies (EMDEs), where large currency movements are more
frequent and central banks have a greater propensity to respond to them (Calvo
and Reinhart 2002; Ball and Reyes 2008). This highlights the importance of
correctly assessing the exchange rate pass-through ratio (ERPTR) to inflation—
defined in this chapter as the percentage increase in consumer prices associated
with a 1 percent depreciation of the effective exchange rate after one year.
A rich literature has demonstrated that currency movements are only partially
transmitted to domestic prices, with effects dissipating through the production
Note: This chapter was prepared by Jongrim Ha, Marc Stocker, and Hakan Yilmazkuday. Background
materials were provided by Sergiy Kasyanenko.
chain. The pass-through to consumer prices goes through various channels, from
direct effects through energy and other commodity prices, to indirect effects
through import prices, wage formation, and profit markups (Bacchetta and van
Wincoop 2003; Burstein and Gopinath 2014; Ito and Sato 2008; McCarthy
2007). Even in the case of internationally traded goods, different forms of
market segmentation and/or nominal rigidities may explain incomplete pass-
through (see Box 5.1 for a literature review).
Many structural factors have been associated with a lower sensitivity of domestic
prices to exchange rate movements, including the degree of competition among
importing and exporting firms (Amiti, Itskhoki, and Konings 2016), the
frequency of price adjustments (Devereux and Yetman 2003; Corsetti, Dedola,
and Leduc 2008; Gopinath and Itskhoki 2010), the composition of trade
(Campa and Goldberg 2010), the level of participation in global value chains
(GVCs; Georgiadis, Gräb, and Khalil 2017), the share of trade invoiced in
foreign currencies (Casas et al. 2017; Gopinath 2015), and the use of currency
hedging instruments (Amiti, Itskhoki, and Konings 2014). A credible monetary
policy framework that supports well-anchored inflation expectations has also
been viewed as an effective way to reduce the pass-through to consumer prices
(Carriere-Swallow et al. 2016; Gagnon and Ihrig 2004; Reyes 2004; Schmidt-
Hebbel and Tapia 2002; Taylor 2000).
Beyond structural factors and country characteristics, the nature of the

macroeconomic shock that triggers an exchange rate movement plays a key role
in determining the size of the associated pass-through (Comunale and Kunovac
2017; Forbes, Hjortsoe, and Nenova 2017; Shambaugh 2008). This reflects the
fact that shocks impacting the exchange rate concurrently affect activity,
markups, productivity, and several other factors that influence price formation
and inflation expectations. It is thus likely that the extent of estimated ERPTRs
will vary widely depending on the shock that triggers them—a possibility that
most empirical studies have not taken into account.
This chapter contributes to a recent strand of the literature that emphasizes the
importance of identifying underlying shocks to assess the transmission of
exchange rate movements to inflation and, therefore, to formulate the correct
monetary policy response. For instance, if the ERPTR associated with monetary
policy changes is higher than the one associated with other types of shocks, there
is a risk that a central bank might underestimate the exchange rate channel of its
actions and maintain an excessively tight (or loose) monetary policy stance
relative to what is needed to stabilize inflation and output. This may lead to
unnecessary fluctuations in activity and make the anchoring of inflation
expectations more difficult to achieve over time.
BOX 5.1 Exchange rate pass-through: A review
Many studies have estimated the exchange rate pass-through to inflation,

producing a wide range of estimates depending on country characteristics as
well as the type of shocks that trigger the exchange rate changes.
Properly measuring the exchange rate pass-through is important for
forecasting inflation and setting monetary policy. Earlier studies generally
estimated the exchange rate pass-through ratio (ERPTR) in a reduced-form
framework, treating exchange rate movements as exogenous rather than
considering the underlying shocks behind such movements.
A group of recent studies emphasizes that different shocks can be associated
with widely different ERPTRs. These studies usually identify underlying
shocks in structural vector autoregression (SVAR) models, highlighting
heterogeneity in the direction and magnitude of ERPTRs, depending on
the nature of the shocks and country characteristics (Shambaugh 2008;
Forbes, Hjortsoe, and Nenova 2017).
Explanatory factors include the monetary policy regime, level of central
bank credibility, trade and financial market openness, degree of
participation in global value chains, and structural features of product and
labor markets.
Against this background, this box addresses the following questions:
• What are the theoretical underpinnings of partial exchange rate
pass-throughs to inflation?
• How do pass-throughs vary depending on the source of shocks?
• What are the key country characteristics affecting pass-throughs?
What are the theoretical underpinnings of partial

exchange rate pass-throughs to inflation?
An incomplete adjustment of prices to exchange rate movements can arise
in the presence of international market segmentation for traded goods,
because of various trade frictions or firms’ ability to practice price
discrimination across international locations. Nominal rigidities may also
help explain the persistence of such deviations over time and lead to a
declining ERPTR across the production chain.
Price discrimination by firms. Producers’ ability to have different pricing
strategies across different segments of international markets is a key feature
BOX 5.1 Exchange rate pass-through: A review (continued)
of most theoretical models of partial ERPTRs. In particular, the pricing-

to-market literature (originally developed by Krugman 1987 and
Dornbusch 1987) places monopolistic firms at the center of international
price discrimination. Exporters can adjust their markups over marginal
cost across different destinations to take into account the demand
conditions and price elasticities encountered in each market (Froot and
Klemperer 1989; Auer and Chaney 2009). In general, models with
heterogeneous consumers give rise to more flexible demand systems that
allow for “optimal” international price discrimination with incomplete
ERPTRs (Goldberg and Hellerstein 2008; Hellerstein 2008; Goldberg
and Verboven 2001; Nakamura and Zerom 2010).
Endogenous firm selection. International trade models of cross-border

production networks have provided further rationale for partial ERPTRs.
In these models, macroeconomic shocks produce a new, endogenously
determined distribution of firms, impacting pricing strategies and
aggregate ERPTRs (Bernard et al. 2003; Chaney 2008; Eaton, Kortum,
and Kramarz 2011; Mayer, Melitz, and Ottaviano 2014; Melitz and
Ottaviano 2008; Rodriguez-Lopez 2011). More competitive and
productive firms, which also tend to source more of their inputs
internationally, have a larger market share, which lowers average pass-
throughs and deepens global value chain integration (Amiti, Itskhoki, and
Konings 2014; de Soyres et al. 2018; Gopinath and Neiman 2014).
Nominal rigidities. Nominal rigidities in local-currency pricing can

account for a less than full pass-through, even when markups are constant.
When prices are sticky, the currency of invoices will determine the rate of
pass-through (Choudhri and Hakura 2015; Devereux, Engel, and
Storgaard 2004; Bacchetta and van Wincoop 2005; Gopinath and
Itskhoki 2010; Flodén and Wilander 2006). In models with nominal price
rigidities, producers opt to invoice in the currency of the origin or
destination, depending on the desired ERPTRs. Exporters facing stronger
competition in the destination markets may choose to invoice in local
currencies to keep prices stable relative to competitors, thus reducing the
overall exchange rate pass-through.
Nontradable input costs. Local nontradable inputs are relatively immune

to exchange rate movements, which tend to lower the exchange rate pass-
through to consumer prices. In particular, distribution costs drive a
significant wedge between producer and retail prices (Burstein, Neves, and
Rebelo 2003; Corsetti and Dedola 2005; Berger et al. 2012). Models with
consumer search (Alessandria 2009; Alessandria and Kaboski 2011) and
inventories (Alessandria, Kaboski, and Midrigan 2010) work in a broadly
similar fashion by creating a disconnect between the border and consumer
prices of imported goods.
How do pass-throughs vary depending on the source of

shocks?
Although structural features play an important role in determining

ERPTRs, the nature of the macroeconomic shocks behind exchange rate
movements has been increasingly emphasized as a determining factor
(Forbes, Hjortsoe, and Nenova 2017). Shocks can act concurrently on
inflation and exchange rates, with varying implications for ERPTRs. In a
literature review, Goldberg and Knetter (1997) document that estimated
exchange rate pass-throughs depend critically on how well identified the
sources of the exchange rate movements are.
Shambaugh (2008) takes this argument a step further by systematically

categorizing exchange rate pass-throughs by type of shock. He estimates a
vector autoregression model with long-run identifying restrictions on
industrial production, the real exchange rate, consumer prices, the nominal
exchange rate, and import prices for 11 mostly advanced economies.
ERPTRs after one year are estimated for shocks to domestic supply,
domestic demand, domestic prices, foreign prices, and import prices. A
foreign price shock has a smaller pass-through rate, close to 0.5, as does a
domestic demand shock, at around 0.4.
Forbes, Hjortsoe, and Nenova (2017, 2018) apply a five-variable SVAR

with short- and long-term identifying restrictions to the United Kingdom
and 26 small, open economies with de facto floating exchange rates during
1990-2015. They estimate sizable ERPTRs in responses to domestic
monetary policy shocks but modest ones in response to domestic demand
shocks. Their estimates of ERPTRs following global shocks (permanent
and transitory) are quite heterogeneous across countries (Figure 5.1.1).
Borensztein and Queijo (2016) follow a broadly similar approach for a
group of South American countries; Comunale and Kunovac (2017)
for Euro Area countries; Cunningham et al. (2017) for a sample of
advanced economies; and Ca’Zorzi, Hahn, and Sanchez (2007) for 12
emerging market and developing economies (EMDEs).

Although ERPTRs were
historically larger in EMDEs, FIGURE 5.1.1 Pass-through
with currency depreciations following different types of
often associated with inflation shocks
crises and subsequent sharp
recessions (Frankel and Rose
1996; Reinhart and Rogoff
2008), they have recently
declined in many countries,
reflecting the shifting nature of
shocks and institutional change
(Carriere-Swallow et al. 2016;
Forbes, Hjortsoe, and Nenova
2017; Tunç 2017).
What are the key country Source: Forbes, Hjortsoe, and Nenova (2017).
Notes: Blue bars depict the range of median shock-
characteristics affecting dependent pass-through estimates across 26
countries, conditional on the shock causing the
pass-throughs? exchange rate to move. The first bar shows the
estimates after a domestic supply shock, the second
after a domestic demand shock, the third after a
Many empirical studies focus domestic monetary policy shock, and the fourth and
fifth after permanent and temporary global shocks,
on the relationship between respectively. The exchange rate pass-through ratios
are measured eight quarters after the shock.
estimated ERPTRs and country Click here to download data and charts.
characteristics. In general,
greater openness to trade and financial transactions, less credible central
banks, more volatile inflation and exchange rates, and lower levels of
market competition are associated with higher ERPTRs.
Various studies emphasize trade openness and the composition of
imported goods (Campa and Goldberg 2005, 2010), central bank
credibility (Taylor 2000; Gagnon and Ihrig 2004; Choudri and Hakura
2006; Mishkin and Schmidt-Hebbel 2007; Coulibaly and Kempf 2010;
Caselli and Roitman 2016; Carriere-Swallow et al. 2016), the degree of
competition in product markets (Devereux, Tomlin, and Dong 2015;
Amiti, Itskhoki, and Konings 2016), inflation volatility (Ca’Zorzi, Hahn,
and Sanchez 2007; Forbes, Hjortsoe, and Nenova 2017), and exchange
rate volatility (Campa and Goldberg 2005). Other studies focus on
microeconomic aspects of price-setting: nominal rigidities (Devereux and
Yetman 2003; Corsetti, Dedola, and Leduc 2008); the role of foreign-
currency pricing, especially in invoicing (Gopinath, Itskhoki, and Rigobon
2010; Gopinath 2015; Devereux, Tomlin, and Dong 2015); the
dispersion of price changes (Berger and Vavra 2015); and the frequency of
price adjustments (Gopinath and Itskhoki 2010). Korhonen and Wachtel
(2006) find that high degrees of dollarization and import penetration
accelerated the speed of pass-through in Commonwealth of Independent
States countries relative to other emerging markets.
Other research indicates that exchange rate pass-through varies over time
and may be subject to regime switching and structural breaks (Ozkan and
Erden 2015; Campa and Goldberg 2005; Cunningham et al. 2017;
Donayre and Panovska 2016; Khalaf and Kichian 2005). Some studies link
this time-varying exchange rate pass-through to the role of domestic
factors, such as the changing composition of imports and shifts in
monetary policy frameworks, or to external factors, such as the increasing
role of China in the global economy (Marazzi et al. 2005; Gust, Leduc,
and Vigfusson 2010).
Against this background, this chapter examines the following questions:
• How have exchange rate movements impacted inflation over time?
• How does the pass-through to inflation depend on the underlying shock

triggering the exchange rate movement?
• What country characteristics are associated with lower pass-throughs?
To answer these questions, the chapter first examines the extent of the
comovement between inflation and exchange rates across 34 advanced
economies and 138 EMDEs, including event studies of significant depreciation
and appreciation episodes. Second, from a series of factor-augmented vector
autoregression (FAVAR) models, the chapter estimates the impact of various
global and domestic shocks on exchange rates and inflation, deriving shock-
specific pass-through ratios.1 The models are estimated from a subsample of 55
countries, including 26 EMDEs. Third, it investigates how country
characteristics affect pass-through ratios, paying a particular attention to
1 Defined as the ratio between the one-year cumulative impulse response of consumer price inflation
and the one-year cumulative impulse response of the exchange rate change to three domestic shocks
(monetary policy, domestic demand, and domestic supply), three global shocks (global demand, global
supply, and oil prices), and one residual shock (risk premium).
monetary policy frameworks, participation in GVCs, and foreign-currency

invoicing.
The main conclusions are as follows:
• Large depreciation episodes continue to be associated, on average, with

more significant increases in consumer price inflation in EMDEs than in
advanced economies. Unconditional pass-throughs tend to increase with the
size of the depreciation in both country groups.
• The relationship between inflation and currency movements depends on

the nature of the underlying shock. Monetary policy shocks are associated
with a higher exchange rate pass-through compared to other domestic
shocks, and global shocks have widely different effects.
• Pass-throughs are generally lower in countries with more flexible exchange

rate regimes and a credible commitment to an inflation target. This, in
turn, facilitates the central bank’s task of stabilizing inflation and makes
exchange rate movements a more effective buffer against external shocks.
The contribution of this chapter to the literature is threefold. First, it utilizes a

rich set of results to shed new light on the heterogeneity of pass-through
estimates across countries and over time.
Second, it supplements a burgeoning empirical literature linking exchange

rate pass-through to underlying shocks in a structural vector autoregression
(SVAR) model framework. This contrasts with traditional reduced-form
approaches that estimate “average” pass-throughs based on conditioning
variables. The estimation of shock-specific pass-throughs refines the analysis of
factors affecting the link between exchange rate movements and inflation.
Third, compared to the few preceding studies that have derived state-dependent
estimates of ERPTRs (Forbes, Hjortsoe, and Nenova 2017, 2018; Shambaugh
2008), this chapter investigates additional shocks and uses a larger sample of
countries. It looks at the impact of three domestic shocks (monetary policy,
demand, and supply), three global shocks (demand, supply, and oil price), and a
residual shock capturing, among other factors, changing risk premiums. A
unique FAVAR framework combining global and domestic developments allows
identification of these different shocks in a unified setup. Moreover, the
identification strategy uses an efficient algorithm to combine sign and zero
restrictions, preserving a certain level of agnosticism (Arias, Rubio-Ramirez, and
Waggoner 2014). Finally, compared to previous studies, this chapter is more
focused on EMDE-specific characteristics, including monetary policy
frameworks, participation in GVCs, and foreign currency invoicing.
The next sections offer key stylized facts about the link between inflation and
exchange rate movements, present estimates of shock-specific ERPTRs, and
demonstrate the importance of structural factors and country-specific
characteristics. The conclusion discusses policy implications and suggests
avenues for future research.
Exchange rate movements and inflation

This section examines the historical relationship between changes in the
nominal effective (trade-weighted) exchange rate and consumer price inflation.
A depreciation (decline in the effective exchange rate) is expected to cause the
domestic price of imports to rise and, depending on a host of factors, higher
consumer prices (a positive pass-through). The first step in this descriptive
analysis examines the impact of large currency movements on consumer price
inflation in cross-country event studies. The second step examines the stability
of the relationship between inflation and currency movements over time.
Inflation and exchange rate movements: Event study
The event study presented in this section explores episodes of large exchange rate
fluctuations, defined as quarterly movements in excess of 5 percent across 34
advanced economies and 138 EMDEs. The rationale for focusing on large
currency fluctuations is twofold. First, such episodes are more likely to induce
detectable changes in prices throughout the entire production chain. This helps
trace factors influencing the exchange rate pass-through across countries.
Second, such an event study allows the estimation of the pass-through
conditional on the size and direction of the exchange rate movement. A
common assumption in the literature is that the relationship between exchange
rate movements and inflation is linear and symmetric. However, prices may
respond differently to large changes in the exchange rate, and depreciations may
generate an asymmetric reaction relative to appreciations. Computing
unconditional pass-throughs associated with different types of exchange rate
movements can help disentangle these effects.
Overall, depreciations of between 5 and 10 percent per quarter have been

associated with a low unconditional pass-through over the past two decades
(Figure 5.1). Median estimates of the same quarter pass-through are close to zero
in advanced economies and around +0.1 for EMDEs (a 10 percent depreciation
in the median EMDE triggers a 1 percent increase in consumer prices after one
quarter). Depreciations of between 10 and 20 percent in a given quarter were
generally accompanied by a higher pass-through, with median values of +0.1 for
advanced economies and +0.2 for EMDEs. Depreciations in excess of 20
percent were associated with pass-throughs of around +0.4 in both groups of

countries, but these events have been far less common recently, which reduces
the reliability of the estimated pass-throughs.
The event study also confirms a broad-based decline in the pass-through among
EMDEs over the past two decades. For depreciations of between 5 and 10
percent, the median pass-through in EMDEs fell by a factor of three from 1980-
98 to 1998-2017. This decline came with a reduction in the frequency and
severity of currency depreciations. Prior to 1998, large depreciation episodes in
EMDEs clustered around periods of U.S. dollar appreciation, often associated
with a tightening of U.S. monetary policy. In some cases, these led to full-blown
currency or debt crises, particularly in Latin America during the 1980s and the
early to mid-1990s, and in Asia during the second half of the 1990s. The
reduced frequency of large depreciations and lower unconditional pass-throughs
over the past two decades may have common causes: enhanced monetary and
fiscal policy frameworks, more flexible exchange rate regimes, accumulations of
foreign exchange reserves, lower current account deficits, and better external
debt management (Frankel, Parsley, and Wei 2005). Unconditional pass-
throughs remained higher among EMDEs with less flexible exchange rate
regimes (those devaluing from currency pegs or other forms of currency
arrangements) and those without inflation targeting central banks.
Appreciation episodes are generally associated with positive, but lower, pass-
throughs compared to depreciations of the same magnitude, with median values
of +0.02 for advanced economies and EMDEs for appreciations of between 5
and 10 percent, and only slightly higher for appreciations of between 10 and 20
percent (Figure 5.2). These results may indicate that currency appreciations
induce a weaker response from import and consumer prices compared to
similar-size depreciations (Brun‐Aguerre, Fuertes, and Greenwood‐Nimmo
2017). However, large currency appreciations are also rare events, making
rigorous conclusions about asymmetric effects difficult to establish in this
context. Overall, the results appear to point to the presence of nonlinearities in
the relationship between exchange rate movements and inflation, including in
EMDEs (Caselli and Roitman 2016).
Inflation and exchange rate correlation: Evolution over time

Although the declining sensitivity of inflation to exchange rate movements has
been extensively documented, this relationship is generally assumed to be stable
in the short term. However, there is growing evidence that pass-throughs can
vary considerably even over short periods of time, making inference from
average values unreliable and potentially misleading for policy evaluation and
forecasting purposes.
FIGURE 5.1 Pass-through during significant currency depreciations

The median pass-through associated with large currency depreciations declined in EMDEs
over the past two decades but remains higher among countries with less flexible exchange
rate regimes and without inflation targeting central banks. The frequency and severity of
depreciation episodes dropped as well.
A. Unconditional pass-through from B. Unconditional pass-through from different

depreciations of 5 to 10 percent depreciation episodes, 1998-2017
C. EMDEs: Unconditional pass-through from D. EMDEs: Unconditional pass-through from

depreciations of 5 to 10 percent, 1998-2017 different depreciation episodes, 1998-2017
E. Frequency of significant exchange rate F. Frequency of significant exchange rate

depreciations: Advanced economies depreciations: EMDEs
Source: World Bank.

Note: Depreciations are defined as negative quarterly changes in the nominal effective exchange rate. The sample
comprises 34 advanced economies and 138 EMDEs. EMDEs = emerging market and developing economies;
IMF = International Monetary Fund; IT = inflation targeting.
A.-D. Pass-throughs are defined as the change in consumer prices after one quarter divided by the depreciation of the
nominal effective exchange rate. The markers refer to the median pass-through.
A.C. The bars show the interquartile range of pass-throughs.
C.D. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others are
considered to have “low” trade openness. Exchange rate and IT regimes are based on IMF classifications (see the
Appendix for details). Energy exporters are defined as in World Bank (2018); all other countries are considered energy
importers. Countries with current account deficits are those with a negative average current account balance over
1998-2017.
FIGURE 5.2 Pass-through during significant currency appreciations

The median pass-through associated with significant currency appreciations is low, but
such episodes are relatively rare.
A. Unconditional pass-through from different B. EMDEs: Unconditional pass-through from

appreciation episodes, 1998-2017 different appreciation episodes, 1998-2017
C. Frequency of significant exchange rate D. Frequency of significant exchange rate

appreciations: Advanced economies appreciations: EMDEs
Source: World Bank.

Note: Appreciations are defined as positive quarterly changes in the nominal effective exchange rate. The sample
comprises 34 advanced economies and 138 EMDEs. EMDEs = emerging market and developing economies; GDP =
gross domestic product; IMF = International Monetary Fund; IT = inflation targeting.
A.B. Pass-throughs are defined as the change in consumer prices after one quarter divided by the cumulative depreciation
of the nominal effective exchange rate following significant depreciation episodes. The markers refer to the median
pass-through associated with different appreciation episodes.
B. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others are
1998-2017.
This instability in pass-through rates can be illustrated by plotting rolling

correlation rates between exchange rate movements and consumer price
inflation over time (Figure 5.3).2 For advanced economies, the median
correlation rate became increasingly positive during the late 1990s (+0.4 in
2 Using a three-year window of the bivariate correlation between the nominal effective exchange rate
depreciation rate in one quarter and the inflation rate in the next quarter. For advanced economies and
EMDEs, correlation rates tend to peak after one quarter, indicating that exchange rate movements have
the strongest impact on inflation with a one-quarter lag.
FIGURE 5.3 Correlations between inflation and nominal effective

exchange rate changes
Correlations between inflation and exchange rate movements vary considerably over time.
A. Advanced economies: Correlation rate B. EMDEs: Correlation rate
C. Average correlation rate D. EMDEs: Average correlation rate, by sub-

groups
Source: World Bank.

Note: EMDEs = emerging market and developing economies; GDP = gross domestic product; IMF = International Monetary
Fund; IT = inflation targeting.
A.B.D. Correlation over a three-year rolling window between inflation and nominal effective exchange rate depreciations
after one quarter. The sample includes 51 economies. The median and interquartile range are for three-year window
correlation during 1995-2018.
C. Q, Q+1, Q+2, and Q+3 represent the correlation between inflation and nominal effective exchange rate depreciations
over the same quarter and after one, two, and three quarters, respectively.
D. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others are
1998-2017.
2000), during the mid-2000s (+0.2 in 2007), and again during the mid-2010s
(+0.5 in 2014). These were periods marked by unusually large monetary policy
shocks or heightened uncertainty over policy actions, providing some evidence of
stronger exchange rate pass-through to inflation during such episodes. In
contrast, correlation rates were close to zero during the recovery in the early
2000s and turned significantly negative during the global financial crisis (-0.5 in
2008-09). They were also close to zero during the latest synchronized upturn in
2017-18. These were periods dominated by shifts in domestic or global demand
conditions, which appear to be associated with a lower sensitivity of inflation to
exchange rate movements.3 These trends were largely shared across countries, as
reflected in similar swings in the upper and lower bands of the interquartile
range of country estimates.4
Among EMDEs, the median correlation also moved close to zero during the
economic recovery in the early 2000s and during the global financial crisis, but it
became increasingly positive after 2010 amid deteriorating supply-side
conditions in many countries, including commodity exporters facing the end of
the commodity supercycle (Baffes et al. 2015).
A wide range of cross-country and time variation in the correlation between
exchange rates and inflation is consistent with the notion that different shocks as
well as country-specific characteristics can shape the response of inflation to
currency movements. These two factors—the source of shocks and country
characteristics—are discussed in the next two sections.
Pass-through to inflation and underlying shocks

A recent strand of the literature on the exchange rate pass-through emphasizes
the importance of identifying the underlying cause of currency movements
(Comunale and Kunovac 2017; Forbes, Hjortsoe, and Nenova 2017, 2018;
Shambaugh 2008). For example, a depreciation driven by monetary policy
easing could be accompanied by larger increases in inflation, as it raises import
prices in the short term and is associated with stronger aggregate demand (and,
consequently, an increase in overall pricing pressures) over the medium term. In
this case, the pass-through should be expected to be positive and large, as
domestic and external forces contribute to higher inflation. In contrast, a
depreciation associated with weaker domestic demand could be accompanied by
lower inflation over time, as the impact of rising economic slack on domestic
prices could outweigh that of higher import prices. In this case, the shock-
specific pass-through could be negative. Therefore, the sensitivity of inflation to
exchange rate movements can vary considerably depending on the
macroeconomic environment and the source of the shocks. This section
quantifies differences in pass-through ratios associated with various global and
domestic shocks.
Methodology. For this empirical investigation, country-specific FAVAR models
were estimated for 29 advanced economies and 26 EMDEs, using quarterly data
between 1971 and 2017. The model provides a multivariate, open-economy
framework that maps domestic and foreign drivers of inflation and the nominal
3 Sharp movements in oil prices around the global financial crisis also affected the correlation between
exchange rate movement and domestic inflation trends around that period.
4 Range between the 25th and 75th percentile of country estimates.
effective exchange rate. The identification strategy is based on the following

assumptions, combining sign and short-term restrictions:5
• A positive domestic demand shock is assumed to raise domestic output

growth and inflation.6
• A positive (contractionary) monetary policy shock is assumed to cause an

exchange rate appreciation, decrease domestic output growth, and reduce
inflation.
• A positive supply shock is assumed to raise output growth but to lower

inflation.
• A positive global demand shock triggers a simultaneous upswing in global

output growth, global inflation, and oil prices.7
• A positive global supply shock leads to higher global output growth and oil
prices but lower global inflation.
• A positive oil price shock induces an increase in oil prices and global inflation
but a drop in global output growth.
• Global shocks can have contemporaneous effects on domestic variables, but

domestic shocks can only influence global variables with a lag.
A two-step procedure is applied to measure shock-specific exchange rate pass-

throughs. First, the exchange rate and inflation responses to these shocks are
mapped separately from impulse response functions. Second—as in Shambaugh
(2008) and Forbes, Hjortsoe, and Nenova (2017, 2018)—the pass-through
is defined as the cumulative impulse response of consumer price inflation
relative to the impulse response of the effective exchange rate over the same
period. The pass-through is measured one year after the initial shock, as in
Shambaugh (2008).
A positive pass-through indicates that a shock triggering a currency depreciation

is followed by an increase in consumer prices, as is generally expected. A
negative value means that a shock triggering a currency depreciation is followed
by a decline in consumer prices.
5Details of the modeling approach are provided in Annex 5.1.

6An alternative specification also assumes that positive domestic demand shocks lead to a
contemporaneous increase in domestic interest rates. See Annex 5.1 for robustness results.
7 Global shocks are derived from a separate tri-dimensional vector autoregression model that
incorporates global output growth, global inflation, and oil price changes, following the approach of
Charnavoki and Dolado (2014) and Uhlig (2005). See Chapter 3 for details.
Exchange rate responses
Since pass-through ratios are defined in this framework as the relative response
of consumer prices and the exchange rate to different global and domestic
shocks, it is important first to investigate the estimated impact of these shocks
on the exchange rate. Empirical studies have shown that fundamentals have
some, albeit limited, predictive power over exchange rate movements. These
fundamentals include changes in relative business cycle positions, monetary
policy stances, risk premiums, and terms of trade (Ca’Zorzi and Rubaszek 2018;
Cheung et al. 2017). In particular, periods of domestic output or investment
contraction are often associated with currency depreciations (Cordella and
Gupta 2015; Landon and Smith 2009; Campa and Goldberg 1999). Monetary
policy easing can also lead to currency depreciations, as a declining interest rate
differential with the rest of the world tends to put downward pressure on the
domestic currency (Chinn and Meredith 2005; Engel 2016). Rising risk
premiums and heightened sovereign default risks can also trigger such
downward pressures (Foroni, Ravazzolo, and Sadaba 2018). Finally, nominal
exchange rates can respond to terms of trade shocks, particularly in commodity
exporters with flexible currency regimes (Aizenman, Edwards, Riera-Crichton
2012; Schmitt-Grohé and Uribe 2018).
Impulse responses from the FAVAR model provide a basis for disentangling the
impacts of different types of domestic and global shocks on the exchange rate.
The results described below are based on a one-year response of the nominal
effective exchange rate to one-standard-deviation shocks. Medians and
interquartile ranges of country-specific estimates are reported for different
groups.8
Domestic shocks. Monetary policy tightening leads to currency appreciations in

all advanced economies and EMDEs (Figure 5.4). Interest rate driven
appreciations are estimated to be larger in EMDEs, particularly among countries
with inflation targeting central banks and in some commodity exporters (Brazil,
Colombia, and South Africa). Stronger domestic demand causes currency
appreciations as well, but the impact is statistically insignificant after one year in
most cases.9 Meanwhile, changes in domestic supply conditions have mixed
effects. This is consistent with the literature arguing that productivity shocks
have uncertain implications for currency movements (Alfaro et al. 2018;
Corsetti, Dedola, and Leduc 2008).
8 An interquartile range is a range between the 25th to the 75th percentile of country estimates within
each country group.

9 In this chapter, statistical inferences are based on 68 percent confidence intervals.
Global shocks. The median impact of global shocks on the exchange rate is close
to zero across countries (Figure 5.5). Obviously, this result is not surprising,
because one country’s currency depreciation is, by definition, another’s
appreciation. Still, domestic currency appreciations are more likely to happen in
the wake of a positive global demand shock, particularly among EMDEs. This
could reflect the fact that the U.S. dollar, which remains the global currency of
exchange, generally depreciates during global upturns. A weaker U.S. dollar, in
turn, typically supports capital inflows and amplifies appreciations in EMDEs,
particularly among countries with current account deficits (Avdjiev et al. 2018).
A positive global supply-side shock has mixed effects, with currency
depreciations observed among some EMDEs that run current account surpluses
(for example, China) and appreciations among some commodity exporters (for
example, Brazil, Colombia, Malaysia, and South Africa). Rising oil prices also
tend to be associated with currency appreciations in oil-exporting economies and
with depreciations in some oil importers.
Relative contributions of global and domestic shocks. On balance, domestic
factors are the dominant drivers of exchange rate fluctuations, accounting for
about two-thirds of currency movements in advanced economies and more than
one-half in EMDEs (Figure 5.6). Although the direction and magnitude of the
impact of global shocks varies substantially across countries, these shocks still
explain around 7 percent of the variance of currency movements in the median
advanced economy and up to 16 percent in the median EMDE. Forbes,
Hjortsoe, and Nenova (2017) present similar results, but they attribute a larger
share of currency movements to global shocks.10 About 25 percent of currency
movements are accounted for by other shocks, which encompass changes in
sovereign and private sector risk premiums. Indeed, shifting expectations about
sovereign default risks can have a significant impact on exchange rate dynamics
(Alvarez, Atkeson, and Kehoe 2009; Foroni, Ravazzolo, and Sadaba 2018).
Estimated pass-through
Shock-specific ERPTRs are calculated from country-specific FAVAR models as
the ratio between the impulse response of inflation and the impulse response of
the exchange rate to different shocks after one year. These conditional pass-
through ratios can help establish a link between cross-country and time
variations in the average ERPTRs and various factors, such as different
sensitivities to shocks, changes in the prevalence of some shocks, improved
policy frameworks, or other structural factors.
Median estimates of pass-through ratios are reported across different country
groups, as well as interquartile ranges across these country groups.
10 At around 30 percent, on average.

FIGURE 5.4 Exchange rate responses to domestic shocks

Monetary policy tightening and, to a lesser degree, positive domestic demand shocks are
accompanied by currency appreciations, particularly among EMDEs that are more open to
trade, have more flexible exchange rate regimes, and have inflation targeting central
banks.
A. Monetary policy shocks B. EMDEs: Monetary policy shocks
C. Domestic demand shocks D. EMDEs: Domestic demand shocks
E. Domestic supply shocks F. EMDEs: Domestic supply shocks
Source: World Bank.

Note: One-year impulse responses of the exchange rate to domestic shocks (monetary policy, domestic demand, and
domestic supply) from country-specific factor-augmented vector autoregression models estimated for 29 advanced
economies and 26 EMDEs over 1998-2017. Bars show the interquartile range and markers represent the median across
countries. A positive number indicates an appreciation. EMDEs = emerging market and developing economies;
IMF = International Monetary Fund; IT = inflation targeting.
B.D.F. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others are
1998-2017.
FIGURE 5.5 Exchange rate responses to global shocks

The effect of global shocks on exchange rates has varied considerably across countries.
However, strengthening global demand is more often followed by domestic currency
appreciations, particularly among EMDEs with floating exchange rate regimes and
inflation targeting central banks. Oil price shocks have opposite effects on the exchange
rates of energy exporters and energy importers.
A. Global demand shocks B. EMDEs: Global demand shocks
C. Global supply shocks D. EMDEs: Global supply shocks
E. Oil price shocks F. EMDEs: Oil price shocks
Source: World Bank.

Note: One-year impulse response of the exchange rate to global shocks (demand, supply, and oil prices) from
country-specific factor-augmented vector autoregression models estimated for 29 advanced economies and 26 EMDEs
over 1998-2017. Bars show the interquartile range and markers represent the median across countries. A positive number
indicates an appreciation. EMDEs = emerging market and developing economies; IMF = International Monetary Fund;
IT = inflation targeting.
1998-2017.
FIGURE 5.6 Variance decompositions of exchange rate movements

Domestic shocks account for about two-thirds of the variation in exchange rates in the
median advanced economy and more than half in the median EMDE after one year.
Monetary policy shocks contributed most to exchange rate variations.
A. Variance decomposition B. Variance decomposition: All countries
C. Variance decomposition: Advanced D. Variance decomposition: EMDEs

economies
Source: World Bank.

Note: Median share of country-specific exchange rate variance accounted for by global, domestic, and exchange rate
shocks based on country-specific factor-augmented vector autoregression models estimated for 29 advanced economies
and 26 EMDEs over 1998-2017. Bars show the interquartile range and markers represent the median across economies.
EMDEs = emerging market and developing economies.
Domestic shocks. Domestic shocks account for over half the variance of
inflation and exchange rates in most countries but are associated with different
ERPTRs depending on their source.
Domestic monetary policy shocks are generally associated with large, positive
ERPTRs (for example, currency depreciations combined with monetary policy
easing are accompanied by significant increases in inflation). Median values
since 1998 are estimated to be +0.2 in advanced economies and +0.3 in EMDEs
(Figure 5.7). Pass-through ratios are generally higher in small, open EMDEs
that have less flexible exchange rate regimes or do not have inflation targeting
central banks (for example, Azerbaijan, Botswana, Honduras, Jordan, the former
Yugoslav Republic of Macedonia, and Morocco). The finding that EMDEs with
inflation targeting central banks tend to have lower than average ERPTRs
provides preliminary evidence that a credible commitment to price stability

helps weaken the responsiveness of inflation to exchange rate movements.
In sharp contrast with monetary policy shocks, domestic demand shocks are
associated with small, negative ERPTRs for most countries (for example, a
negative domestic demand shock tends to be associated with currency
depreciation and declining inflation). Median values at around -0.07 are similar
for advanced economies and EMDEs. Among EMDEs, the ERPTR is generally
more negative in countries with less flexible exchange rate regimes and without
inflation targeting central banks.
Domestic supply-side shocks are associated with positive ERPTRs but with lower
median values compared to monetary policy shocks (less than +0.1 in advanced
economies and EMDEs). However, most of these estimates are insignificant,
with wide variations across country groups.
Global shocks. Global shocks account for a smaller proportion of the variance of
exchange rate movements and are associated with more variations in estimated
ERPTRs.
ERPTRs associated with global demand shocks tend to be positive among

EMDEs (for example, currency depreciation coupled with higher inflation),
particularly in economies with less flexible exchange rate regimes and without
inflation targeting central banks (Figure 5.8). However, in several EMDEs,
ERPTRs are estimated to be negative (currency depreciation coupled with lower
inflation), including among some energy exporters (for example, Azerbaijan and
Colombia). Estimated ERPTRs are statistically insignificant in over one-fifth of
advanced economies and one-third of EMDEs.
Oil price shocks tend to be associated with widely different ERPTRs. The
median ERPTR is positive for many energy exporters (for example, Azerbaijan,
Colombia, and Malaysia) but negative in advanced economies, except the
United States (partly due to the negative correlation between the U.S. dollar and
oil prices). The estimates are insignificant in over one-half of advanced
economies and almost two-thirds of EMDEs.
Global supply shocks tend to generate large variations in ERPTRs as well, with a
negative median estimate for advanced economies and a positive one for
EMDEs. However, the estimates are insignificant for nearly three-quarters of
advanced economies and about two-thirds of EMDEs.
Other shocks. The FAVAR models attribute nearly a quarter of currency

movements to residual shocks that may be linked to shifting risk premiums and
other unmeasured factors. The median ERPTR associated with such shocks is
FIGURE 5.7 Pass-through associated with domestic shocks

The exchange rate pass-through is large and positive when currency movements
are associated with monetary policy changes. It is smaller when currency movements are
associated with changes in domestic supply conditions and negative when they
are associated with changes in domestic demand conditions. Among EMDEs, the pass-
through is generally lower among countries with more flexible exchange rate regimes and
A. Monetary policy shocks B. EMDEs: Monetary policy shocks
C. Domestic demand shocks D. EMDEs: Domestic demand shocks
E. Domestic supply shocks F. EMDEs: Domestic supply shocks
Source: World Bank.

Note: Pass-throughs are defined as the ratio between the one-year cumulative impulse response of consumer price
inflation and the one-year cumulative impulse response of the exchange rate change estimated from factor-augmented
vector autoregression models for 29 advanced economies and 26 EMDEs over 1998-2017. A positive pass-through means
that a currency depreciation is associated with higher inflation. Bars show the interquartile range and markers represent the
median across countries. EMDEs = emerging market and developing economies; IMF = International Monetary Fund;
1998-2017.
FIGURE 5.8 Pass-through associated with global shocks

Exchange rate pass-throughs vary widely, depending on the source of the global shock
and country characteristics. For EMDEs, the pass-through is generally the lowest among
countries that are less open to trade, have more flexible exchange rate regimes, and have
A. Global demand shocks B. EMDEs: Global demand shocks
C. Global supply shocks D. EMDEs: Global supply shocks
E. Oil price shocks F. EMDEs: Oil price shocks
Source: World Bank.

that a currency depreciation is associated with higher inflation. Bars show the interquartile range and markers represent
the median across countries. EMDEs = emerging market and developing economies; IMF = International Monetary Fund;
GDP = gross domestic product; IT = inflation targeting.
B.D.F. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others
are considered to have “low” trade openness. Exchange rate and IT regimes are based on IMF classifications (see the
1998-2017.
FIGURE 5.9 Pass-through associated with exchange rate shocks

The exchange rate pass-through is close to zero when currency movements are associated
with residual exchange rate shocks (not defined as domestic or global shocks).
A. Exchange rate shocks B. EMDEs: Exchange rate shocks
Source: World Bank.

median across countries. EMDEs = emerging market and developing economies; IMF = International Monetary Fund;
B. Countries with “high” trade openness are defined as those with above median trade-to-GDP ratios; all others are
1998-2017.
close to zero for advanced economies and EMDEs (Figure 5.9). However, it
tends to be negative in EMDEs with less flexible exchange rate regimes,
indicating that the direct effect of exchange rate changes on import prices is
more than offset by other factors in those countries.
Past empirical studies disentangling the impacts of different types of shocks on

exchange rates and inflation have reached broadly similar conclusions (Box 5.1).
For instance, Forbes, Hjortsoe, and Nenova (2017) estimate a five-variable
SVAR model with short- and long-term identifying restrictions using a sample
of 26 small, open economies with de facto floating exchange rates. They report
relatively large, positive ERPTRs in response to domestic monetary policy shocks
but modest ones for responses to domestic supply shocks and negative ERPTRs
for domestic demand shocks. They also find that pass-throughs associated with
global shocks vary considerably in magnitude and direction. Shambaugh (2008)
tests for cross-country differences in shock-specific ERPTRs and concludes that
domestic demand shocks have a smaller pass-through relative to other types of
shocks.
Average pass-through. To facilitate a comparison with other empirical studies, a

weighted average of shock-specific pass-through ratios is computed, using shares
FIGURE 5.10 Average pass-through

Over the past two decades, the average pass-through dropped close to zero in advanced
economies and somewhat below +0.1 in EMDEs, albeit with considerable differences
across countries.
A. Average pass-through B. EMDEs: Average pass-through, 1998-2017
Source: World Bank.

median across countries. Shock-specific pass-throughs are aggregated using shares of currency movements accounted for
by each type of shock as weights. EMDEs = emerging market and developing economies.
A. Full sample estimations are over 1971 to 2017 but can vary at the country level depending on data availability (see the
Appendix for details).
of currency movements accounted for by each type of shock as weights. This

summary measure reflects the average sensitivity of inflation to exchange rate
movements over the entire estimation period.
Overall, average ERPTRs are estimated to have declined in advanced economies

and EMDEs in recent decades. The median estimate for advanced economies
averaged +0.08 since 1970 but was close to zero over 1998-2017 (Figure 5.10).
For EMDEs, the median value averaged +0.15 since 1970, but declined to
+0.08 over 1998-2017.
Among larger EMDEs, the average ERPTR in China is estimated at +0.08 since
1998, somewhat below previously reported estimates (Jiang and Kim 2013; Shu
and Su 2009; Wang and Li 2010). For India, the average ERPTR is estimated at
+0.14, broadly in line with previous studies (Bhattacharya, Patnaik, and Shah
2008; Forbes, Hjortsoe, and Nenova 2017; Kapur and Behera 2012). For the
Russian Federation, it is measured at +0.11, consistent with findings of the
Central Bank of the Russian Federation (2014). For Brazil, the average ERPTR
is estimated at +0.06 since 1998, toward the lower end of other studies (Forbes,
Hjortsoe, and Nenova 2017; Ghosh 2013; Nogueira and Leon-Ledesmab
2009). For South Africa, the ERPTR is estimated at +0.07, broadly in line with
the evidence presented in Kabundi and Mbelu (2018).
Pass-through to inflation and structural factors

The findings of this chapter confirm that the nature of the shocks behind
exchange rate movements plays a critical role in determining the direction and
magnitude of the exchange rate pass-through to inflation. Country
characteristics matter as well. Monetary policy frameworks and structural
factors, such as the degree of international trade integration and foreign-
currency invoicing, can make domestic prices more or less sensitive to exchange
rate fluctuations. In EMDEs, improvements in monetary policy frameworks are
credited for being a major force in pushing average ERPTRs down over the past
two decades.
Monetary policy framework and credibility. The empirical literature has

generally found ERPTRs to be smaller among advanced economies and in
EMDEs with inflation targeting or more credible central banks (Carriere-
Swallow et al. 2016; Gagnon and Ihrig 2004; Reyes 2004; Schmidt-Hebbel and
Tapia 2002). Over the past two decades, an increasing number of central banks
have adopted inflation targets and enhanced their credibility, which has helped
reduce ERPTRs (Mishkin and Schmidt-Hebbel 2007; Coulibaly and Kempf
2010). This tendency has been observed across EMDEs, including in many
economies in Asia (Prasertnukul, Kim, and Kakinaka 2010), Latin America
(Ghosh 2013), and Eastern Europe and Central Asia (Maria-Dolores 2010;
Yüncüler 2011). More generally, countries with lower inflation and less volatile
exchange rates have been found to have lower average pass-throughs as well
(Forbes, Hjortsoe, and Nenova 2017).
The consequences of inflation targeting frameworks and greater central bank

credibility and independence are discernible in estimated ERPTRs for domestic
and global shocks. In particular, the ERPTR associated with domestic monetary
policy shocks is significantly smaller in EMDEs with more independent centrals
banks (Figure 5.11). An improvement of the central bank independence index
from one standard deviation below the sample mean to one standard deviation
above it can reduce the pass-through ratio associated with monetary policy
shock by half. In countries with more independent central banks, inflation
responds less to exchange rate movements triggered by global demand and oil
price shocks as well. This implies that countries with flexible exchange rates can
better absorb external shocks through currency adjustments without threatening
price stability.
Trade openness and participation in global value chains. The feedback between
trade openness and exchange rate pass-through is multifaceted. A larger share of
foreign products in domestic markets implies a potentially larger role for
exchange rate movements in driving aggregate inflation (Benigno and Faia 2016;
Soto and Selaive 2003). This would be consistent with a higher average ERPTR
in more open economies. However, increased foreign competition in domestic
markets will tend to reduce the pricing power of domestic firms, which will tend
to reduce the ERPTR (Auer 2015; Berman, Martin, and Mayer 2012; Gust,
Leduc, and Vigfusson 2010). More competitive or productive firms also tend to
have larger market shares and source more of their inputs internationally
(Gopinath and Neiman 2014), further contributing to a decrease in the ERPTR
(Amiti, Itskhoki, and Konings 2014).
The degree of GVC integration could play an important role as well. By

fragmenting production and increasing the share of intermediate goods in total
trade, higher GVC integration could weaken the response of import and export
prices to exchange rate movements. Such an effect has been identified in
advanced economies and EMDEs (Amiti, Itskhoki, and Konings 2014; de
Soyres et al. 2018; Georgiadis, Gräb, and Khalil 2017).11
Several economies in East Asia and Pacific and Eastern Europe and Central Asia
have high GVC integration and low average pass-throughs; however, a clear link
between GVC integration and pass-throughs could not be established, partly
reflecting the correlation between GVC participation and other variables
associated with trade openness (Figure 5.12; Chinn 2014).
Foreign-currency invoicing. Having a large share of imports invoiced in a

foreign currency could amplify the sensitivity of import and export prices to
exchange rate movements (Devereux, Tomlin, and Dong 2015; Gopinath
2015). The ERPTR to import and export prices has been found to be
particularly elevated for countries with a high share of imports priced in U.S.
dollars (Casas et al. 2017; Korhonen and Wachtel 2006). More generally,
domestic prices in highly dollarized economies tend to react more to currency
movements relative to other countries, since tradable and nontradable goods are
priced in a foreign currency (Carranza, Galdon-Sanchez, and Gomez-Biscarri
2009; Reinhart, Rogoff, and Savastano 2014; Sadeghi et al. 2015). However, the
selection of the pricing currency could itself depend on the desired level of the
11 For instance, using a structural two-country model, Georgiadis, Gräb, and Khalil (2017) show that
the sensitivity of an economy’s local-currency production costs to exchange rate changes rises as the
country participates more in GVCs by importing a larger share of its intermediate inputs. The increased
sensitivity of the economy’s local-currency production costs to exchange rate changes translates into a
lower sensitivity of its foreign-currency export prices to exchange rate changes. As the economy’s foreign-
currency export price equals its trading partner’s local-currency import price, an increase in the
economy’s GVC participation implies a fall in its trading partner’s exchange rate pass-through to local-
currency import prices.
FIGURE 5.11 Central bank credibility and pass-through

A growing number of countries have adopted explicit inflation targets, and central bank
independence has increased since 2000. Greater central bank independence has tended
to dampen the pass-through to inflation of exchange rate movements stemming from
monetary policy shocks and is also associated with lower average ERPTRs.
A. Central bank independence and inflation B. Central bank independence and exchange
targeting frameworks rate pass-through from monetary policy
shocks
C. Central bank independence and exchange D. Central bank independence and average
rate pass-through from monetary policy exchange rate pass-through in EMDEs
shocks in EMDEs
Source: World Bank.

Note: The central bank independence index is computed by Dincer and Eichengreen (2014). An increase in the index
means greater central bank independence. Pass-throughs are defined as the ratio between the one-year cumulative
impulse response of consumer price inflation and the one-year cumulative impulse response of the exchange rate change
estimated from factor-augmented vector autoregression models for 29 advanced economies and 26 EMDEs over 1998-
2017. A positive pass-through means that a currency depreciation is associated with higher inflation. Bars show the
interquartile range and markers represent the median across countries. EMDEs = emerging market and developing
economies; ERPTR = exchange rate pass-through ratio; IMF = International Monetary Fund; IT = inflation targeting.
B. Low and high central bank independence are defined as below or above the sample average.
C.D. The sample only includes EMDEs with floating exchange rate regimes according to the IMF classification (see the
D. Shock-specific pass-throughs are aggregated using shares of currency movements accounted for by each type of shock
as weights.
exchange rate pass-through, preserving the causal relationship (Gopinath,

Itskhoki, and Rigobon 2010).
A significantly larger share of foreign-currency (and U.S. dollar) invoicing in

most EMDEs relative to advanced economies could partly help explain a
difference in average ERPTRs across these two groups. However, the
FIGURE 5.12 Global value chain participation and pass-through

Higher global value chain participation is associated with lower pass-throughs in some
EMDEs, but the relationship is tenuous across the full sample.
A. Global value chain participation B. Global value chain participation and pass-
through from monetary policy shocks
C. Global value chain participation and D. Global value chain participation and aver-
pass-through from monetary policy shocks in age exchange rate pass-through in EMDEs
EMDEs
Source: OECD; World Bank.

Note: Global value chain data are from the OECD-WTO TiVA database. The selected indicator is foreign value added as a
percent of gross exports. Pass-throughs are defined as the ratio between the one-year cumulative impulse response of
consumer price inflation and the one-year cumulative impulse response of the exchange rate change estimated from
factor-augmented vector autoregression models for 29 advanced economies and 26 EMDEs over 1998-2017. A positive
pass-through means that a currency depreciation is associated with higher inflation. Bars show the interquartile range and
markers represent the median across countries. EMDEs = emerging market and developing economies; IMF =
International Monetary Fund; OECD = Organisation for Economic Co-operation and Development; TiVA = Trade in Value
Added; WTO = World Trade Organization.
B. Low and high value chain participation are defined as below or above the sample average.
as weights.
relationship between the size of the pass-through and the share of imports
invoiced in foreign currencies appears to be tenuous (Figure 5.13). For instance,
EMDEs with a higher share of foreign-currency invoicing and more elevated
ERPTRs are also characterized by less flexible currency regimes, and the absence
of an inflation targeting central bank. Overall, the share of foreign-currency
invoicing is merely a secondary factor explaining cross-country differences in
estimated ERPTRs.
FIGURE 5.13 Foreign-currency import invoicing and pass-through

The share of foreign-currency invoicing does not seem to account for cross-country
variations in ERPTRs in EMDEs.
A. Share of imports invoiced in foreign B. Share of foreign-currency invoicing and

currency pass-through from monetary policy shocks
C. Share of foreign-currency invoicing and D. Share of foreign-currency invoicing and

pass-through from monetary policy shocks in average exchange rate pass-through in
EMDEs EMDEs
Source: Gopinath 2015; World Bank.

Note: Share of imports invoiced in foreign currency based on data for 50 countries calculated by Gopinath (2015).
Pass-throughs are defined as the ratio between the one-year cumulative impulse response of consumer price inflation and
the one-year cumulative impulse response of the exchange rate change estimated from factor-augmented vector
autoregression models for 29 advanced economies and 26 EMDEs over 1998-2017. A positive pass-through means that a
currency depreciation is associated with higher inflation. Bars show the interquartile range and markers represent the
median across countries. EMDEs = emerging market and developing economies; ERPTR = exchange rate pass-through
ratio; IMF = International Monetary Fund.
B. Low and high share of foreign-currency invoicing are defined as below or above the sample average.
as weights.
Conclusion
Monetary authorities in EMDEs have long been worried that significant
exchange rate fluctuations could jeopardize price stability and force disruptive
monetary policy responses. To alleviate these concerns, some countries adopted
managed currency arrangements or leaned against undesirable currency
movements with aggressive policy changes—a practice that has been dubbed
“fear of floating” (Calvo and Reinhart 2002; Ball and Reyes 2008). However, a
lack of exchange rate flexibility can amplify global shocks, encourage speculative
attacks, and make it more difficult to anchor inflation expectations credibly.
This in turn tends to increase the sensitivity of inflation to exchange rate
movements, constraining the effectiveness of monetary policy and, as a result,
limiting the adjustment of relative prices and the efficacy of expenditure-
switching mechanisms as a buffer against global shocks.
This underscores the importance of properly evaluating the exchange rate pass-
through to inflation under various circumstances and identifying the factors
affecting it. Such an evaluation is of fundamental importance to formulating the
appropriate and proportionate monetary policy response to currency
movements.
This chapter investigates the relationship between inflation and exchange rate
movements, contingent on the nature of the underlying shocks. The chapter
uses FAVAR models to compute seven shock-specific pass-through ratios for
each country. These ratios are then grouped and aggregated to identify common
patterns.
Overall, domestic shocks are found to be a dominant driver of exchange rate
fluctuations across most countries but are associated with significantly different
pass-throughs to inflation, depending on their characteristics. In particular,
domestic monetary shocks are generally accompanied by higher than average pass-
throughs, particularly in countries with less flexible exchange rate regimes and
without inflation targeting central banks. In contrast, domestic demand shocks
are typically associated with negative and mostly insignificant pass-through
ratios, due to the offsetting effects of growth and exchange rate channels (for
example, weakening domestic demand giving rise to currency depreciation and
declining inflation). Global shocks accounted for a smaller proportion of
exchange rate movements and are associated with considerable heterogeneity of
the estimated ERPTRs, depending on country characteristics and the source of
the shock.
Differences in shock-specific ERPTRs could have important implications for
monetary policy. For example, the exchange rate pass-through during an initial
economic recovery phase could be low, reflecting the predominance of domestic
demand shocks. However, appreciation caused by unexpected monetary policy
tightening could be associated with a significantly larger degree of pass-through.
Failing to take these factors into account may lead central banks to tighten
policy more than needed to stabilize inflation, creating unnecessary fluctuations
in activity.
Monetary policy frameworks and other country-specific characteristics affecting
the sensitivity of domestic prices to currency fluctuations matter as well. In
particular, a credible commitment to maintaining low and stable inflation has
been one of the key factors behind the weak pass-through of even sizable
depreciations to inflation in advanced economies and EMDEs over the past two
decades. Looking at the cross-section of ERPTR estimates for EMDEs, an
improvement of the central bank independence index from one standard
deviation below the sample mean to one standard deviation above the sample
mean could potentially reduce the pass-through ratio associated with domestic
monetary policy shocks by half. This highlights a self-reinforcing feedback
between central bank credibility and price stability. Similarly, currency
movements triggered by global demand and oil price shocks also have more
limited effects on inflation when central banks are credibly committed to an
inflation target. This speeds up relative price adjustments and reinforces the
benefit of flexible currency regimes.
Overall, the downward trend in exchange rate pass-through presented in this
chapter can be connected to improvement in central bank policies and more
solid anchoring of inflation expectations. Other structural factors, including
growing integration in GVCs, may have played a role as well, but the analysis is
not able to account for the cross-country differences in pass-through ratios.
Future research could investigate more formally the relationship between

estimated ERPTRs and structural factors, such as the degree of value chain
participation and foreign-currency invoicing practices in EMDEs. This could
take the form of event studies around significant policy or other structural
changes. The analysis of shock-specific pass-through could also be extended to
different inflation measures, for example, import price, producer price, gross
domestic product deflator, and core consumer price inflation. This could shed
more light on the source of incomplete pass-through to consumer price inflation
and help guide monetary policy decisions. Finally, nonlinearities in the exchange
rate pass-through could be further investigated, looking at the direction and size
of the various shocks under consideration.
L
Bo y t = α + ∑i=1 Bi yt-i + εt
t t
ƒt π, global ƒ tY, global
π it it
it
it
ut
ut t
− + 0 0 0 0   t
utY , global   GlobalDemand 
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utY, domestic  = *   DomesticDemand 
* * + + − *  t
  ,domestic    
ut  * * * + − − *   tDomesticSupply 
 I ,domestic   * 
* * * * + *   MonetaryPolicy 
ut    t 
u ER   * * * * * + +   ExchangeRate 
 t   t 
affect country-specific variables (without any sign or zero restrictions). A positive

country-specific supply or demand shock increases country-specific output
growth. Furthermore, a country-specific supply shock reduces domestic
inflation, whereas a country-specific demand shock increases domestic inflation.
A positive exchange rate shock (corresponding to an appreciation of the domestic
currency) is assumed to increase the exchange rate, but its impact on other
domestic variables is left unrestricted. Finally, a positive interest rate shock
(corresponding to a contractionary monetary policy) initially increases the
domestic interest rate and results in an appreciation of the domestic currency,
while it decreases domestic output growth and inflation. All country-specific
shocks are assumed to affect country-specific variables on impact through the
corresponding sign restrictions, although the robustness checks (below) also
consider such restrictions lasting for an alternative number of periods.
The system is estimated on a country-by-country basis using quarterly data with
two lags, as in Charnavoki and Dolado (2014). The Bayesian estimation used
searches for 1,000 successful draws of at least 2,000 iterations with 1,000 burn-
ins. The results shown in the chapter are based on the median of these 1,000
successful draws and 68 percent confidence sets at the country level, although
alternative presentation methodologies (for example, the median target, as in Fry
and Pagan [2011]) are considered as a robustness check below. In the Bayesian
estimation, Minnesota priors proposed by Litterman (1986) are used; since the
Minnesota prior assumes that the variance-covariance matrix of residuals is
known, we use the entire variance-covariance matrix of the vector autoregression
estimated by ordinary least squares. For the actual estimation, the identification
strategy through the algorithm introduced by Arias, Rubio-Ramirez, and
Waggoner (2014) is used, where the standard Cholesky decomposition is
employed together with an additional orthogonalization step that is necessary to
produce a posterior draw from the correct distribution for structural vector
autoregression coefficients.
The results for the role of global and domestic shocks in domestic inflation are
presented as median point estimates across countries. Interquartile ranges
indicate the range from the 25th to the 75th quartile of country-specific
estimates (for example, Forbes, Hjortsoe, and Nenova [2017]). For
presentational clarity, and consistent with other studies in the literature, the
country-specific confidence sets are calculated but not presented.
Exchange rate pass-through
Following Shambaugh (2008) and Forbes, Hjortsoe, and Nenova (2017), for
each country, the exchange rate pass-through ratio (ERPTR) is defined as the
ratio of the response of country-specific inflation to the response of the nominal
exchange rate changes following a given shock. The sign of the ratio is inverted,
so that a positive ERPTR denotes a situation in which a currency depreciation is

accompanied by rising inflation:
Response of country-specific inflation

ERPTR= –
Response of country-specific nominal exchange rate change
As in Forbes, Hjortsoe, and Nenova (2017) and others, the ERPTR is calculated
based on one-year cumulative impulse response functions of the endogenous
variables. Since the Bayesian estimation results are based on 1,000 successful
draws satisfying the sign restrictions, the country-specific ERPTRs are
represented as the median (and 68 percent confidence sets) of successful draw-
specific ERPTRs (ERPTRs are calculated for each successful draw individually
before being used for a country-specific statistic).
Robustness checks
Several robustness checks were performed:
• An alternative number of periods (two-quarter periods) were considered in
imposing sign restrictions in identifying country-specific structural shocks.
The resulting pass-through ratios are largely comparable to the benchmark
estimates (Figure A.5.1.1).
• An alternative specification of sign restrictions was considered where
positive domestic demand shocks led to a contemporaneous increase in
country-specific interest rates. The pass-through ratios associated with
domestic demand and monetary policy shocks in this specification are very
similar to the benchmark estimates (Figure A.5.1.2).
• Alternative presentations of 1,000 successful draws were considered,
following Fry and Pagan (2011), such that rather than presenting the
median across 1,000 successful draws, the draw that was closest to the
median across 1,000 successful draws (the median target) was used. The
same strategy was applied to calculate the corresponding 68 percent
confidence sets, again following Fry and Pagan (2011).
Data
The sample includes 29 advanced economies and 26 EMDEs with at least 10
years (40 quarters) of continuous data for the variables in the domestic block,
but the sample period differs across countries (see Table A.5.1.1 for details).
Long-term trends of the variables are eliminated using the local mean method,
as in Stock and Watson (2012). The following variable definitions are used as
inputs into the FAVAR estimation.
FIGURE A.5.1.1 Pass-through: One versus two-quarter sign

restrictions
A. Monetary policy shocks B. Global demand shocks
C. Domestic demand shocks D. Global supply shocks
E. Domestic supply shocks F. Oil price shocks
Source: World Bank.

inflation and the one-year cumulative impulse response of the exchange rate change to shocks from country-specific
factor-augmented vector autoregression models estimated for 51 economies (29 advanced economies and 22 EMDEs)
over 1998-2017. A positive pass-through means that a currency depreciation is associated with higher inflation. Bars show
the interquartile range and markers represent the median across countries. In the alternative specification, sign restrictions
are applied to the current quarter and next quarter. EMDEs = emerging market and developing economies.
FIGURE A.5.1.2 Pass-through: Additional sign restriction to identify

domestic demand shocks
A. Monetary policy shocks B. Global demand shocks
C. Domestic demand shocks D. Global supply shocks
E. Domestic supply shocks F. Oil price shocks
Source: World Bank.

inflation and the one-year cumulative impulse response of the exchange rate change to shocks from country-specific
factor-augmented vector autoregression models estimated for 51 economies (29 advanced economies and 22 EMDEs)
over 1998-2017. A positive pass-through means that a currency depreciation is associated with higher inflation. Bars show
the interquartile range and markers represent the median across countries. In the alternative specification, an additional
sign restriction was imposed, assuming that a positive domestic demand shock leads to a contemporaneous increase in
domestic interest rates. EMDEs = emerging market and developing economies.
•
Yt i =  global
Y ,i
f t Y , global + etY ,i
 ti =  global
 ,i
f t  , global + et ,i
 ti Yt i i t
ƒtπ,global ƒtY,global
TABLE A.5.1.1 List of countries and sample periods

Country Sample period Country Sample period
Australia 1970:2 - 2017:4 India 1993:3 - 2017:4
Austria 1990:1 - 2017:4 Israel 1985:3 - 2017:4
Azerbaijan 2005:3 - 2017:4 Italy 1979:2 - 2017:4
Belgium 1970:2 - 2017:4 Jordan 1999:3 - 2017:4
Bulgaria 1994:4 - 2017:4 Japan 1989:3 - 2017:4
Brazil 1998:3 - 2017:4 Korea, Republic of 1991:3 - 2017:4
Botswana 1994:4 - 2017:4 Luxembourg 1999:3 - 2017:4
Canada 1970:2 - 2017:4 Mexico 1989:1 - 2017:4
Switzerland 1970:3 - 2017:4 Macedonia, FYR 2008:1 - 2017:4
Chile 1986:3 - 2017:4 Malta 1999:3 - 2017:4
China 1984:4 - 2017:4 Malaysia 2004:4 - 2017:4
Colombia 1994:4 - 2017:4 Morocco 1995:4 - 2017:4
Costa Rica 1997:3 - 2017:4 Netherlands 1982:3 - 2017:4
Czech Republic 1992:4 - 2017:4 Norway 1979:2 - 2017:4
Germany 1970:2 - 2017:4 New Zealand 1974:3 - 2017:4
Denmark 1970:2 - 2017:4 Philippines 1987:3 - 2007:3
Dominican Republic 2004:3 - 2017:3 Poland 1992:1 - 2017:4
Egypt, Arab Rep. 2002:4 - 2017:2 Portugal 1986:2 - 2017:4
Spain 1977:3 - 2017:4 Russian Federation 2000:1 - 2017:4
Finland 1987:3 - 2017:4 Slovak Republic 1996:1 - 2017:4
France 1970:2 - 2017:4 Slovenia 2002:3 - 2017:4
United Kingdom 1970:2 - 2017:4 South Africa 1981:3 - 2017:4
Greece 1994:4 - 2017:4 Sweden 1983:3 - 2017:4
Honduras 2005:4 - 2017:4 Thailand 2000:4 - 2017:4
Hungary 1995:4 - 2017:4 Tunisia 2000:4 - 2017:4
Indonesia 1990:3 - 2017:4 Turkey 2007:1 - 2017:4
Ireland 1984:3 - 2017:4 United States 1970:2 - 2017:4
Iceland 1988:3 - 2017:4
Note: Countries with at least 40 quarters of data have been included.

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Global developments—perhaps technological in nature, such as the
tremendous growth of online shopping—could be helping to hold
down inflation in a persistent way in many countries.
Janet L. Yellen (2017)
Increased competition and changes in technology are driving down

the prices of many of the things we buy…. A question we are
grappling with here is how much further this process has to run.
Philip Lowe (2017)
There are reasons why low inflation is a phenomenon, and they

should be set out clearly. However, there is no reason to assume
that inflation will no longer rise. If the central banks aren’t
careful, we could very quickly end up with higher inflation rates
again…. It would be totally irresponsible to declare that inflation
has been conquered for once and for all.
Agustín Carstens (2018)

PART C
INFLATION
Low-Income Country Considerations
CHAPTER 6
Inflation in Low-Income Countries
Most of the variation in inflation among low-income countries (LICs) over the past
decades is accounted for by external shocks. More than half of the variation in core
inflation rates among LICs is due to global core price shocks, compared with one-
eighth in advanced economies. Global food and energy price shocks account for
another 13 percent of core inflation variation in LICs—half more than in advanced
economies and one-fifth more than in non-LIC emerging market and developing
economies. This points to challenges in anchoring domestic inflation expectations,
which have been most evident among LICs with floating exchange rates, especially in
cases where central bank independence has been weak.
Introduction
Low and stable inflation helps promote long-term economic growth, and it has
become the primary objective of the monetary policies of central banks around
the world (Chapter 1).1 One of the key factors that determine the ability of
central banks to achieve this objective is the degree to which inflation
expectations are well anchored (Blinder et al. 2008). To steer inflation
expectations, central banks typically establish a nominal policy anchor, which
can either be quantity-based (for example, broad money supply or M2), price-
based (for example, the exchange rate), or a target for inflation itself.2
Inflation expectations are shaped by many factors, including the history of
inflation and the degree of credibility of the central bank (Chapter 4). If the
central bank’s commitment to its nominal anchor has high credibility,
temporary inflation shocks—for example, due to commodity price shocks—will
not set inflation expectations adrift. A central bank’s credibility, in turn,
depends on whether it is (i) committed to achieving its objective of low and
stable inflation, (ii) has sufficient institutional capability to deliver on its
commitment, and (iii) has a track record of achieving its objective.
Ensuring monetary policy credibility is particularly important for low-income
countries (LICs), which have historically had to cope with frequent domestic
Note: This chapter was prepared by Jongrim Ha, Anna Ivanova, Peter Montiel, and Peter Pedroni.
1 Central banks are responsible for maintaining not only price stability (low and stable inflation) but
also (especially more recently) financial stability (the soundness of the domestic financial system). The
instruments of monetary policy are generally used mainly for the former objective; a different set of
instruments is generally used for the latter (Taylor 2005; Hammond, Kanbur, and Prasad 2009).
2 The use of targets for the growth of monetary aggregates has generally fallen out of favor since the
1980s, at least in advanced economies, because of such problems as instability in relationships between
monetary growth and inflation and the divergent behavior of different aggregates.
supply shocks, especially weather-related shocks to agricultural production that

feed through to food prices (Frankel 2011).3 Moreover, LIC central banks face
several other impediments to their ability to anchor inflation expectations. First,
they are likely to face a broader set of objectives, compared with those in
advanced economies and other emerging market and developing economies
(EMDEs); for example, the exchange rate is more likely to be a separate and
important policy objective (Rodrik 2007; Berg and Miao 2010).4 Second, the
weak institutional capacity of central banks in LICs may complicate monetary
policy management. Third, central banks in LICs generally lack a track record of
low inflation. Finally, globalization has increased LICs’ exposure to external
price shocks.5
Although LICs have achieved significant progress in reducing inflation over the
past two decades, they have done so in an international environment
characterized by significantly lower worldwide inflation. How much of LICs’
progress represents homegrown gains in central bank credibility, and how much
is simply the result of a more favorable global environment? This chapter
attempts to shed some light on this issue.
The chapter addresses the following questions:
• How has inflation in LICs evolved?
• How well anchored are inflation expectations in LICs?
• What country characteristics have been associated with stronger anchoring?

In this chapter, the question of the degree of anchoring of medium-term
inflation expectations in LICs is tackled by estimating a novel heterogeneous
panel structural vector autoregression (SVAR) model.6 The model examines the
3 The definition of LICs in this chapter follows the World Bank. The LICs in the sample include
Afghanistan, Burundi, Benin, Burkina Faso, Comoros, Ethiopia, Guinea, Liberia, Mali, Mozambique,
Malawi, Niger, Rwanda, Senegal, Sierra Leone, Togo, Tanzania, and Uganda.
4 An important reason is that, as argued in the “fear of floating” literature (for example, Calvo and
Reinhart 2002; Agénor and da Silva 2013), nominal exchange rate fluctuations may be particularly
disruptive in the EMDE context, due to the prevalence of balance sheet currency mismatches arising from
“original sin” and inadequate domestic financial regulation. Another reason is the thinness of the foreign
exchange market in many cases, with a lack of stabilizing hedging and speculation. Under these
conditions, LIC central banks may seek to pursue stability of the nominal exchange rate.
5 This not only includes a direct channel via import prices, but also a variety of indirect channels.
Annex 6.1 summarizes the literature on monetary policy challenges in LICs and the channels through
which globalization may change the environment in which LIC central banks operate.
6 The heterogeneous panel SVAR methodology, which is a variant of the Pedroni (2013) methodology,
allows analyzing the consequences of various unanticipated global and domestic inflation shocks on the
domestic core consumer price index. Rather than using pooled estimation, the approach incorporates
group mean panel estimation methods to avoid inconsistent estimation that can occur under
pooled methods when the dynamics associated with endogenous variables are heterogeneous. See Annex
6.2 for details.
extent to which core inflation in LICs has remained stable in the face of a variety
of external shocks, including shocks to global core, energy, and food price
inflation, and other shocks transmitted to the domestic economy through
exchange rate fluctuations. The assessment is made based on the degree of
sensitivity of domestic core inflation, which is determined by the degree of
anchoring of inflation expectations, to external shocks. The estimation is based
on a monthly panel data set that covers 104 countries (25 advanced economies
and 79 EMDEs, including 18 LICs) for 1970M2-2016M12. The data set
contains at least 36 months of continuous data for each country, for six
variables—headline consumer price index (CPI), food CPI, energy CPI, core
CPI, nominal effective exchange rate (NEER), and rainfall. Differences across
income groups and subgroups in LICs in the extent to which domestic core
inflation performance has been insulated from international factors are analyzed
in terms of country characteristics, institutional factors, and policy regimes
under a simple ordinary least squares regression framework.
The chapter’s principal conclusions are as follows.
LICs, like other EMDEs, have experienced higher average levels and volatility of
headline inflation than have advanced economies. However, the level and
volatility of headline inflation have declined in all three country groups over the
past two decades. The fall in inflation volatility in LICs is largely accounted for
by declines in the volatility of core and energy price inflation. Food price
inflation volatility has remained elevated.
Among LICs, core inflation has tended to be lower in countries with lower
public debt ratios, fixed exchange rates, a higher degree of capital account
openness, and greater central bank transparency. Although these results are
largely consistent with those for advanced economies and other EMDEs, the
effects of these characteristics seem to be more prominent for LICs.
Core inflation in LICs was more susceptible to external disturbances than in the
other country groups. Around three-quarters of the variation in domestic core
inflation rates among LICs was accounted for by external inflation shocks, and
very little by shocks to domestic core inflation. This result is exactly opposite of
that of advanced economies where only a quarter of the variation in domestic
core inflation is explained by global inflation shocks.
Consistent with the findings in the other chapters in this report, domestic
characteristics appear to matter not just for the level of domestic core inflation,
but also for determining the susceptibility of core inflation to external shocks,
although further research is needed to solidify this evidence.
Importantly, however, the results indicate that what sets LICs apart may not be
so much that they differ from the other country groups in terms of these
characteristics, but that these characteristics appear to operate differently in the

LIC environment. Notably, although LICs that fix their exchange rates seem to
succeed in anchoring inflation expectations about as well as other economies,
those that float have had a much more difficult time in anchoring inflation
expectations. This finding suggests that LICs may have in essence imported their
anti-inflation credibility.
This chapter presents the results of what is the first investigation reported in the
literature of the effects of various inflation shocks, domestic and global, on core
inflation in a large group of countries, with a specific focus on LICs. The study
takes advantage of the flexibility of a heterogeneous panel SVAR framework and
a large data set that includes core inflation series for 18 LICs and 61 other
EMDEs. The empirical framework makes possible the analysis of the impact of
global and domestic shocks on core inflation in different groups of countries in a
unified framework. Moreover, it helps identify the global component of core
inflation endogenously and produces a parsimonious representation of the
common and idiosyncratic components of core inflation in the countries in the
sample. To help identify the exogenous component of domestic agricultural
supply shocks, which are typically associated with food price inflation, the study
uses rainfall data as an exogenous instrument.7 Finally, the chapter also
contributes to the literature by analyzing the country characteristics that help
explain differences in core inflation responses to shocks between LICs and other
country groups.
The next section documents the evolution of inflation over time and across
countries, with special focus on LICs. The following section examines the
impact of global and domestic inflation shocks on core inflation in LICs, using a
heterogeneous panel SVAR model. The subsequent section distills the country
characteristics associated with a larger role of global shocks. The final section
concludes with a discussion of policy implications for LICs’ control of inflation.
Evolution of inflation in LICs

Data for two periods are examined: 1980-99 and 2000-16. In both periods,
LICs, like other EMDEs, generally experienced higher levels and volatility of
consumer price inflation than did advanced economies (Figure 6.1). This is true
of headline, core, food, and energy price inflation. The level and volatility of
inflation declined between the two periods in each of the three groups, but the
level and volatility of headline and core inflation in LICs remained generally
higher than in advanced economies. Median headline inflation in LICs was
around 6 percent in 2000-16, three times median inflation in advanced
7 The relevance of the instrumental variable is tested using statistical methods. It is significant at the 5
percent level. Refer to Annex 6.2 for details on the test results.
economies. As Chapter 1 demonstrates, inflation performance in LICs has

improved markedly over the past three decades but the decline happened later
(starting in the 1990s) than in advanced economies (starting in the late 1970s).
Inflation volatility in LICs has also declined in recent decades (except food price
inflation). This decline in volatility is not simply the result of the decline in
median inflation among LICs: the cross-country correlation between the level of
inflation and its volatility has tended to be much lower in LICs than in other
country groups.8 The higher volatility of inflation in LICs suggests that these
countries may have experienced more frequent and/or larger shocks that tended
to destabilize the inflation rate, or that their inflation rates have been more
susceptible to shocks.
Food and energy prices, like other primary commodity prices, are known to be
more volatile than the prices of services and manufactured goods. The
historically high volatility and the lower correlation between inflation levels and
inflation volatility in these countries, may therefore be the result of greater
sensitivity of inflation in LICs to global commodity prices. Indeed, simple
correlations reveal that food inflation, but not energy inflation, has been a more
important driver of fluctuations in headline inflation in LICs and other EMDEs
than in advanced economies (Figure 6.1). For core inflation, however, the
evidence is more mixed: its correlation with food and energy inflation has not
been clearly higher in LICs than in the other two country groups. The food and
energy components of the CPI have historically been more volatile in LICs and
other EMDEs than in advanced economies, reflecting the closer link of
consumer prices with primary commodity prices in the former groups of
countries, where food and energy have embed in them smaller services
component than in advanced economies. Combined with the greater
importance of food in LIC consumption baskets, it is expected that movements
in global food price inflation have played a relatively more important role in
inflation variation in LICs.
Median core inflation has tended to be lower in LICs with the following
features: greater capital account openness; lower public debt ratios, fixed
exchange rate regimes, higher degrees of central bank independence and
transparency, higher degrees of participation in global value chains, and, to a
lesser extent, higher degrees of trade openness (Figure 6.2). The findings for
advanced economies and other EMDEs are similar to those for LICs, except that
advanced economies with relatively high public debt have tended to have lower
core inflation. Higher degrees of capital account openness, fixed exchange rate
8 The correlation coefficient between the level and volatility of headline inflation (median across
countries) is around zero in LICs for 1980-2016; the coefficients for other EMDEs and advanced
economies are 0.48 and 0.50, respectively.
FIGURE 6.1 Inflation levels and volatility, by country group
Headline, food, energy, and core consumer price inflation in LICs and other EMDEs have
typically been higher and more volatile than in advanced economies. Inflation and its
volatility have declined across all country groups in the past two decades, with a
particularly pronounced fall in inflation volatility in LICs (except for food). Nonetheless,
headline and core inflation in LICs, and their volatility, have remained generally higher than
in advanced economies. Food inflation has been a more important driver of fluctuations in
headline inflation in LICs and other EMDEs than in advanced economies.
A. Median inflation B. Inflation volatility
C. Correlation of headline and food inflation D. Correlation of headline and energy inflation
E. Correlation of core and food inflation F. Correlation of core and energy inflation
Source: Haver Analytics; International Monetary Fund International Financial Statistics; World Bank.
Note: All inflation rates are annual. Headline inflation uses a balanced panel for 1980-2016, including 154 countries (29
advanced economies, 98 EMDEs, and 27 LICs). Core inflation uses a balanced panel for 1980-2016, including 54 countries
(27 advanced economies, 24 EMDEs, and 3 LICs). Food inflation uses a balanced panel for 1980-2016, including 104
countries (29 advanced economies, 61 EMDEs, and 14 LICs). Energy inflation uses a balanced panel for 1980-2016,
including 55 countries (27 advanced economies, 25 EMDEs, and 3 LICs). EMDEs here exclude LICs. AEs = advanced
economies; EMDEs = emerging market and developing economies; LICs = low-income countries.
A.B. Simple averages of median annual inflation or inflation volatility.
B. Inflation volatility is measured as the standard deviation of annual inflation rates for the past 10 years.
C.-F. The non-stationary part of each series is eliminated using the methodology by Stock and Watson (2012).
regimes, and greater central bank transparency are associated with more
pronounced differences in core inflation in LICs than in advanced economies
and other EMDEs.
Although greater reliance on exports of primary commodities and less financial
openness than in other country groups have continued to characterize LICs in
recent years, structural changes, including changes in macroeconomic
institutions and policy regimes, may have helped reduce inflation and its
volatility in these countries (Chapter 1). In broad terms,
• Trade openness has increased for all country groups since the early 1990s,
with the degree of openness as well as its evolution over time being similar
in advanced economies and EMDEs (including LICs). Although capital
account openness has also increased for all groups since the early 1990s, it
remains much lower in EMDEs than in advanced economies and has
increased at a much slower pace.
• The proportion of EMDEs with pegged exchange rates fell sharply after the
collapse of the Bretton Woods system in the early 1970s but stabilized in
the mid-1990s and has been stable since then.
• An index of central bank independence and transparency is markedly lower
in LICs and other EMDEs than in advanced economies, although it
underwent a notable increase between 1991 and 2016.
Transmission of shocks into core price inflation

Methodology. To examine how well anchored core inflation is in LICs, a
heterogeneous panel SVAR methodology is adopted to identify the effects of
various global and domestic inflation shocks on domestic core CPI inflation in
an orthogonalized reduced-form setting.9 In particular, the panel SVAR
structure includes a 3 x 3 block of global variables, namely, global energy, global
food, and global core price inflation obtained by the cross-sectional average of
individual country inflation rates, with the three variables arranged in this
order.10 It also includes a 3 x 3 block of panel variables, composed of individual
9 The approach can be thought of as an adaptation of the Pedroni (2013) methodology, which relaxes
the diagonality of the loading matrix for the common versus idiosyncratic orthogonalized shocks in a way
that is particularly well suited for reduced form Cholesky analysis through the use of global versus
domestic block Granger causality restrictions in the panel. See Annex 6.2 for details.
10 One could also consider using principal component or dynamic factor estimates in place of the
global variables. However, a combination of observed global variables and cross-section averages is used in
this chapter for three reasons: (i) cross-sectional averages tend to be close proxies for the first principal
component (Pesaran 2006); (ii) even if they differ slightly, asymptotically as the number of countries gets
large, which one is used should not matter for the panel vector autoregression method in terms of
orthogonalizing global core shocks from domestic shocks; and (iii) the data set is unbalanced, which
makes the estimation of the dynamic factors more cumbersome.
FIGURE 6.2 Median core inflation, by country characteristics
Core inflation has tended to be relatively low in LICs, other EMDEs, and advanced
economies with greater capital account openness, lower public debt ratios (except in
advanced economies), fixed exchange rates, higher central bank transparency, greater
participation in global value chains, and, to a lesser extent, greater trade openness.
A. Trade openness B. Capital account openness
C. Public debt ratio D. Exchange rate regime
E. Central bank transparency F. Participation in global value chain
Source: Dincer and Eichengreen 2014; Haver Analytics; International Monetary Fund International Financial Statistics;
Chinn and Ito 2018; Shambaugh 2004; World Bank; World Integrated Trade Solution.
Note: Based on median annual core inflation across 145 countries (34 advanced economies, 91 EMDEs, and 20 LICs)
from 1980 to 2016. Countries with “high” are defined as those with values above the median; all others are considered
“low.” EMDEs here exclude LICs. AEs = advanced economies; CBI = central bank transparency index; EMDEs = emerging
market and developing economies; GDP = gross domestic product; GVC = global value chain; LICs = low-income
countries.
A.B. Trade and capital account openness are based on trade-to-GDP (percent) and the Chinn and Ito (2018) index,
respectively.
C. Percent of GDP.
D. The exchange rate regime is based on the classification by Shambaugh (2004).
E. Based on the CBI by Dincer and Eichengreen (2014). The higher the index is, the more transparent and independent
the central bank is.
F. A country is classified as well integrated into the GVC if one of the following two conditions is met: the sum of backward
and forward participation in GVCs is greater than the median of the sample in a particular year, or the sum of intermediate
exports and imports as a percent of GDP is greater than the median of the sample in a particular year. All other countries
are defined as having “low” GVC participation.
country food inflation, core inflation, and the NEER, with the three panel
variables arranged in this order. Each block is then orthogonalized via a standard
Cholesky decomposition, and additional restrictions are imposed such that the
domestic variables do not have an impact on the global variables, while the
global variables are permitted to have an impact on the country-specific
variables.11 An important issue is that identified domestic food price shocks can
be endogenous to domestic core inflation in the case that both variables are
significantly influenced by common components, presumably domestic demand
shocks. To avoid this, domestic food inflation is instrumented by external
variables, rainfall and the square of rainfall, which reflect exogenous shocks such
as weather events.12 Finally, all dynamics are permitted to be heterogeneous
across countries, so that the distribution of country-specific impulse response
functions (IRFs) can be estimated (Annex 6.2).
• The cumulative response of domestic core inflation to unanticipated
innovations in the three global inflation measures is computed as the
response to a standardized 1 percentage point increase in the relevant global
inflation rate. A muted response of domestic core inflation is interpreted as
weaker transmission of the global shocks into domestic core inflation.
• Next, variance decompositions for domestic core inflation are computed,

which supplement the information contained in the IRFs by providing
estimates of the portion of variation in domestic core inflation that is
explained by global shocks. It is expected that if inflation expectations are
well anchored, then the variance of domestic core inflation is more likely to
be explained primarily by its own domestic core price shocks, and that
relative price shocks (global or domestic) will have more modest effects.
• The values of the IRFs and variance decompositions are then projected on
institutional and policy characteristics of each country. This allows us to
determine the characteristics associated with relatively high versus low
response rates of domestic core inflation to various global inflation
innovations, and to assess which characteristics are more closely associated
with well-anchored inflation expectations in LICs.
Impact of global shocks. Medians and interquartile ranges of the cumulative

IRFs of domestic core inflation (which are equivalent to responses of the level of
the log CPI) in advanced economies, non-LIC EMDEs, and LICs are shown in
11 In other words, this chapter takes a two-step estimation process. First, the global block is estimated
and fixed. Second, the global block is used to help in the selection of parameters for the domestic block,
but not vice versa (see Annex 6.2 for details).
12 More specifically, the predicted value of domestic food inflation from a regression of food inflation
rates on rainfall and rainfall squared is used as a proxy for domestic food inflation net of demand-side
effects. This proxy is included as one of the endogenous variables in the vector autoregression framework.
Figure 6.3, for 6 and 18 months after the shock, to illustrate the persistence of
the impact. During the sample period, 1970-2016, core inflation responded very
differently in LICs, compared with advanced economies and other EMDEs, to
global core price shocks. A 1 percentage point increase in global core inflation
increased median core inflation in LICs by close to 0.6 percentage point after 18
months, compared with less than 0.2 percentage point in advanced economies
and other EMDEs. Thus, LICs appear to import more of the fluctuations in
core global inflation than do the other country groups. Next, the effects on
domestic core inflation of international relative price changes is considered, in
the form of separate shocks to global food and energy inflation, holding global
core inflation constant. Shocks to global food inflation have more notable
consequences for domestic core inflation in LICs. A 1 percentage point increase
in global food inflation raised median core inflation in LICs by around 0.1
percentage point (and by up to 0.3 percentage point) within six months, larger
than the effects in advanced economies and other EMDEs. With respect to
shocks to global energy inflation, median core inflation in LICs responded more
sharply and quickly than that in advanced economies and other EMDEs,
although with more heterogeneous responses across countries.
These results likely reflect the relatively large weight of food more generally, as
well as the relatively large weights of imported food and energy, in headline CPI
in LICs, and the weaker response of many LIC central banks to the “second-
round” effects of these shocks that allow them to be transmitted to core prices.
Alternatively, it could also be the case that labor can shift wages in response to
these shocks in these countries. Shocks to global core, food, and energy prices all
tend to create increases in domestic core inflation in LICs. However, core
inflation in LICs appears to be more sensitive to global core inflation than to
changes in international relative prices of food and energy. By contrast, other
EMDEs show limited sensitivity to global core price shocks, but they more
closely resemble LICs in their response to international prices of food and
energy. Core inflation in advanced economies displays minimal sensitivity to
changes in global core inflation and international energy inflation, but some
sensitivity to changes in the international price of food, although less than that
of LICs.
Impact of domestic food price shocks. Next, the dynamic response of core
inflation to domestic food price shocks is examined (Figure 6.4). Such shocks
are likely to contain a strong endogenous component—they are likely, in part,
to be responses to variables that similarly affect domestic core inflation. The
estimation therefore uses rainfall measures (rainfall and rainfall squared) to
isolate domestic food supply shocks. Since consumer prices in LICs contain
relatively large food components, and since much of the food consumed in these
FIGURE 6.3 Response of core inflation to global price shocks
The median response of domestic core inflation to global core price shocks is relatively
large for LICs, compared to other EMDEs and advanced economies, 6 and 18 months after
the shocks, although with significant variation in responses among LICs. There is long-
lasting impact with some delay in LICs, hinting at the possibility of spillovers from
advanced economies. The median response to global energy price shocks is relatively
small, with no large differences across country groups. The response to global food price
shocks is larger in LICs than in advanced economies and other EMDEs, and there is also
substantial variation in responses across LICs.
A. Response to global core price shocks B. Response to global food and energy price
shocks
Source: World Bank.

Note: Cumulative IRFs after 6 and 18 months of domestic core inflation following a 1 percentage point increase in inflation
measures. Medians and interquartile ranges (25th and 75th percentiles) of IRF distributions are shown for each country
group. The results are based on a heterogeneous panel SVAR model with 104 countries (25 advanced economies, 61
EMDEs, and 18 LICs) between 1970m2 and 2016m12. EMDEs here exclude LICs. See Annex 6.2 for details.
AEs = advanced economies; EMDEs = emerging market and developing economies; IRF = impulse response function;
LICs = low-income countries; SVAR = structural vector autoregression.
countries is produced in large domestic agriculture sectors, the expectation was

that supply shocks to domestic food prices would tend to destabilize core
inflation in LICs, with smaller effects on core inflation in other EMDEs and
advanced economies. Indeed, the results find that a supply-driven domestic food
price shock tended to raise median core inflation in LICs, and to have a
negligible effect on core inflation in advanced economies and other EMDEs
(Figure 6.4). However, the effect in LICs is short-lived, fading within six
months of the shock.13
13 Three possible interpretations of this finding may be mentioned. First, food price inflation seems to
be more volatile and less persistent in LICs than in other countries (Figure 6.1), so that although
domestic supply shocks may be more frequent and larger than in the other country groups, they may also
be rapidly reversed, suggesting that, if the core price level is itself more flexible in LICs, the effects of
domestic food price shocks in those countries may be short-lived. Second, food price subsidies tend to be
used more commonly and more intensively in LICs than in the other country groups. To the extent that
these keep the prices paid by consumers below producer prices, increases in prices received by domestic
producers may have a muted effect on consumer prices. Third, assuming that domestically produced food
cannot be easily substituted for imported food, the adjustment to international food price shocks
through, for example, government subsidies may be costlier than the adjustment to domestic food price
shocks, which can eventually be mitigated by adjustment in domestic food production.
Impact of exchange rate shocks. Finally, the NEER shock, which is the last
variable in the Cholesky ordering, effectively picks up all shocks that move the
NEER and are not covered by the first five shocks. Accordingly, the response of
domestic core inflation to these NEER disturbances indicates the extent of the
exchange rate pass-through to core inflation, irrespective of the underlying shock
to the NEER. The estimated pass-through is more pronounced in LICs than in
advanced economies or other EMDEs (Figure 6.4).14 This may again reflect a
weaker anchoring of inflation expectations in LICs than in the other country
groups, due to weaker commitment to medium-term inflation objectives on the
part of LIC central banks and greater challenges to that commitment posed by
larger imported components of headline CPI.
Impacts of the shocks, by exchange rate regime. To shed more light on the
differences between LICs and other country groups in the transmission of global
and domestic shocks into domestic core inflation, IRFs were estimated
separately for countries with fixed and flexible exchange rate regimes (Figure
6.5). For advanced economies and other EMDEs, the response of domestic core
inflation to global core price shocks was larger in countries with fixed exchange
rate regimes. However, the opposite was true for LICs: the response to global
core inflation was found to be less pronounced for LICs with fixed exchange rate
regimes. An interpretation could be that LICs with fixed exchange rates are
more successful in anchoring inflation expectations than those with flexible
exchange rates. This may be because weak institutions make a credible
commitment to price stability difficult without a credible anchor in the form of
a fixed exchange rate.
Contributions of the shocks to core inflation variation. Variance

decompositions of core inflation were examined for the three country groups,
using within-group medians (Figure 6.6). The key differences were found
between advanced economies, on the one hand, and LICs and other EMDEs on
the other. Consistent with substantially stronger anchoring of domestic
inflation expectations in advanced economies, more than three-quarters of the
variance of core CPI inflation rates in these economies is explained by shocks to
core inflation. In LICs and other EMDEs domestic core inflation is
overwhelmingly explained by shocks to global core inflation. The variance share
of global core price shocks in the total variation of domestic core inflation is
around 60 percent for both these income groups. The contribution of shocks to
domestic core inflation, by contrast, is much smaller. The share of domestic core
inflation explained by global food and energy shocks is moderately larger for
14 This finding is overall consistent with the findings in Chapter 5 where the estimates of the pass-
through ratio are on average greater in EMDEs than in advanced economies, although the country group
in the chapter includes few LICs.
FIGURE 6.4 Response of core inflation to shocks to food prices and

exchange rates
The median response of domestic core inflation to domestic food price shocks is notably
larger in LICs than in advanced economies and other EMDEs. The response of domestic
core inflation to an NEER shock (a catch-all shock) is also larger in LICs, followed by other
EMDEs and advanced economies, which is consistent with the literature on exchange rate
pass-through. The pass-through rate is around -0.1 (and up to -0.3) 18 months after the
shock, but with substantial variation in responses across LICs; the impact is relatively
long-lasting.
A. Response to domestic food price shocks B. Response to exchange rate shocks
Source: World Bank.

Note: Cumulative IRFs after 6 and 18 months of domestic core inflation following a 1 percentage point increase in domestic
food inflation or exchange rate change. Medians and interquartile ranges (25th and 75th percentiles) of IRF distributions
are shown for each country group. The results are based on a heterogeneous panel SVAR model with 104 countries (25
advanced economies, 61 EMDEs, and 18 LICs) between 1970m2 and 2016m12. See Annex 6.2 for details.
AEs = advanced economies; EMDEs = emerging market and developing economies; IRF = impulse response function;
LICs = low-income countries; NEER = nominal effective exchange rate; SVAR = structural vector autoregression.
LICs than for advanced economies and other EMDEs. In LICs, global food and
energy price shocks account for 12 percent of core inflation variation—half more
than in advanced economies and one-fifth more than in non-LIC EMDEs. In
line with the results from the IRFs, this result may suggest that central banks in
LICs have not succeeded in anchoring inflation expectations in the face of
shocks to inflation rates, and that much of LIC inflation seems to have been
driven by spillovers from advanced economies and other EMDEs. This is
discussed in more detail in the next section.
Country characteristics and the roles of shocks

Decomposition of core inflation variation by country group
Differences in structural characteristics, institutions, and policy regimes might
explain the differences in the inflation process among LICs. To shed light on the
contributions of these factors, variance decompositions are compared for the
estimated response of core inflation 18 months after a shock across country
groups, using group medians. The country characteristics are central bank
transparency and independence, the public sector debt-to-gross domestic
product (GDP) ratio (an indicator of potential fiscal dominance), the exchange
rate regime, and the degrees of international trade and financial integration. For
each characteristic, two subgroups are distinguished in each of the three main
country groups: one consisting of countries with “high” values of the relevant
characteristic and the other comprising countries with “low” values. The extent
to which inflation performance has been homegrown is inferred from the share
of the variance of domestic core inflation that is accounted for by domestic core
inflation itself, rather than by external or domestic food price shocks.15
• Central bank transparency and independence. For each country group, the
differences between the two subgroups are quite pronounced: in countries
with a high level of central bank transparency, external shocks play a less
important role than in those with a low degree of central bank transparency
(Figure 6.6). This suggests that inflation expectations are better anchored in
the former than in the latter. However, although central bank transparency
seems to matter for all country groups, it seems to play a greater role among
LICs and other EMDEs in insulating them from external shocks than it
does in advanced economies. Thus, there appear to be EMDE-specific and
LIC-specific factors at play.
• Public debt. Even independent and transparent central banks may be unable
to resist pressures to provide financing to the fiscal authorities when public
sector debt is very high, such that monetary restraint might trigger a
solvency crisis for the government. Empirically, across all the country
groups, economies with relatively high public-sector debt-to-GDP ratios
exhibit a larger role for external shocks in explaining the variance of core
inflation, and this effect is particularly pronounced for LICs (Figure 6.6).
Moreover, external shocks explain a larger share of the variance in core
inflation in LICs with higher public sector debt ratios than in any of the
other subgroups. A somewhat surprising result among advanced economies
is that high debt ratios appear to be associated with low inflation (Figure
6.2). This result may reflect that once monetary policy credibility is
established, as is the case in many advanced economies, countries may be
able to afford to accumulate higher debt without destabilizing
expectations.16
15 The differences in IRFs between LIC subgroups are quite similar to the differences in variance
decompositions. Higher public debt, lower central bank transparency, and lower capital account
openness, which all may capture weaker monetary policy credibility, are associated in LICs with stronger
responsiveness of domestic core inflation to global core price shocks. Trade openness does not appear to
make an important difference for LICs’ response to the global core.
16 It may also capture low-inflation, high-debt outcomes in advanced economies in the wake of the
global financial crisis or the role of a few advanced economies (such as Italy and Japan) where high levels
of public debt have gone together with low inflation for reasons not considered here.
FIGURE 6.5 Response of core inflation to global core price shocks
LICs with fixed exchange rates are better able than floaters to insulate their domestic core
inflation from global core and food price shocks. However, LIC-floaters fare better at
managing global energy price shocks. In contrast, core inflation in advanced economies
with floating exchange rates is generally less sensitives to global price shocks. The results
for other EMDEs are mixed.
A. Response to global core price shock B. Response to global food price shock
C. Response to global energy price shock D. Response to domestic food price shock
Source: Shambaugh 2004; World Bank.

Note: Cumulative IRFs after 6 and 18 months of domestic core inflation following a 1 percentage point increase in inflation
measures. Medians and interquartile ranges (25th and 75th percentiles) of IRF distributions are shown for each country
group. The results are based on a heterogeneous panel SVAR model with 104 countries (25 advanced economies, 61
EMDEs, and 18 LICs). Exchange rate regimes are based on the classification by Shambaugh (2004) between 1970m2 and
2016m12. EMDEs here exclude LICs. AEs = advanced economies; EMDEs = emerging market and developing economies;
IRFs = impulse response functions; LICs = low-income countries; SVAR = structural vector autoregression.
• Financial and trade openness. Panels D and E in Figure 6.6 compare variance
decompositions across countries with different degrees of international trade
and financial openness. If international financial integration, which brings
the possibility of an abrupt reversal in capital flows, imposes more discipline
on monetary policy makers and helps anchor inflation expectations
over time, this could help explain why advanced economies, which are
generally more financially open, exhibit relatively low sensitivity to
external inflation shocks, with the lowest sensitivity of all in their highly
open subgroup. A similar relationship is exhibited by LICs: for countries
with higher capital account openness, the variance share of global shocks is
about 50 percent, and for countries with lower capital account openness, the
FIGURE 6.6 Contribution of inflation shocks to core inflation

variation
In advanced economies, variations in core inflation are largely explained by domestic core
price shocks; in LICs and other EMDEs, they are mostly explained by global core price
shocks, possibly reflecting spillovers from advanced economies. The share of core inflation
explained by global food and energy shocks is largest in LICs. In advanced economies
and other EMDEs, the response to global core price shocks is larger in countries with fixed
exchange rates, whereas the opposite is true for LICs. Higher public debt, less central
bank transparency, and less capital account openness have been associated with stronger
responses of core inflation in LICs to global core price shocks.
A. Income group B. Central bank transparency
C. Public debt D. Trade openness
E. Capital account openness F. Exchange rate regime
Source: Dincer and Eichengreen 2014; Haver Analytics; International Monetary Fund International Financial Statistics;
Shambaugh 2004; World Bank.
Note: Forecast error variance decompositions (forecasting horizon: 18 months) based on medians across countries within
each group. The results are based on a heterogeneous panel SVAR model with 104 countries (25 advanced economies,
61 EMDEs, and 18 LICs). EMDEs here exclude LICs. AEs = advanced economies; EMDEs = emerging market and
developing economies; GDP = gross domestic product; LICs = low-income countries; SVAR = structural vector
autoregression.
B.-E. Countries with “high” characteristics are defined as those with values above the median; all others are considered
“low.”
B. Based on the central bank transparency index by Dincer and Eichengreen (2014).
C. Classification of countries is “high” and “low” based on government debt as a percent of GDP.
D.E. Measures of trade and capital account openness are based on trade (exports plus imports)-to-GDP ratios and the
Chinn and Ito (2018) index, respectively.
F. The exchange rate regime is based on Shambaugh (2004).
share is greater than 80 percent. The difference between the more and less
integrated subgroups of LICs is larger than in the other country groups.
Trade openness, which may also serve as a disciplining device, does not seem
to play an important role in the sensitivity of domestic core inflation to
global core shocks in LICs, although LICs with higher trade openness show
smaller variance shares for global food and energy shocks. In the other
country groups, higher trade openness has tended to be associated with
higher variance shares for external factors. The latter could reflect that
higher trade openness may be associated with higher exposure to global
shocks.
• Exchange rate regime. The effects of exchange rate regimes differ between
advanced economies and non-LIC EMDEs, on the one hand, and LICs on
the other (Figure 6.6). Ex ante, it might be expected that fixed exchange
rate regimes would be associated with stronger transmission from external
inflation shocks to domestic core inflation. This is because small countries
that fix will tend to import the inflation performance of their trading
partners, whereas those that float can, in principle, control their domestic
inflation rates independently. This indeed seems to be what is observed in
the case of advanced economies, and to a lesser extent, non-LIC EMDEs:
shocks to global core inflation account for a much larger fraction of the
variance of domestic core inflation in fixed regimes than in floating regimes.
For LICs, however, these findings are reversed: core inflation in floaters is
less robust in the face of external shocks than in countries that fix. This may
reflect the challenges faced by LIC central banks. Because their domestic
inflation rates are determined largely by those of their trading partners, LICs
with credibly fixed exchange rates may be characterized
by inflation expectations that tend to be anchored to the “normal” inflation
experience of their trading partners and not be disrupted by transitory
external inflation shocks. By contrast, LICs with floating regimes
can avail themselves of no such external anchor; their anchor for inflation
expectations has to be homegrown. In the face of the challenges,
LIC central banks may find it difficult to provide such an anchor. In its
absence, transitory external inflation shocks may create inflation
expectations, which become self-fulfilling (discussed more fully in
Annex 6.1).
Correlates of the impacts of shocks on core inflation
The discussion above is suggestive and intuitive, but it does not quantify the
implications of changes in the country characteristics. To investigate more
comprehensively the implications of marginal variations in a wide set of country
characteristics, all possible bivariate relationships between the country
characteristics and estimated responses (and variance shares) 6 and 18 months

after the shocks were systematically explored.
Methodology. Three conceptually distinct types of investigation were

conducted.
• First, the country characteristics most likely to be important in explaining

the differences in the magnitudes of the cumulative IRFs and variance
decompositions between LICs and the other country groups were examined.
This was done by first exploring whether an LIC dummy for the response
was significant in a regression that also included only an EMDE (non-LIC)
dummy and a constant, and then checking whether the addition of any
country characteristics in the regression rendered the LIC dummy
insignificant.
• Second, policies that would allow LICs to reduce the transmission of global
food, energy, and core price shocks to domestic core inflation were explored
using two approaches: studying the marginal association of country
characteristics attributable to policies with the cumulative IRFs of domestic
core inflation to global shocks, and studying the marginal association of
similar characteristics with the variance contributions of global shocks to
domestic core inflation variation.
• Third, the existence of an “LIC effect” was tested further by examining

whether the responses of the dependent variables to country characteristics
differed systematically between LICs and the other country groups. To this
end, a series of cross-section estimations were conducted, using the entire
sample of 104 countries, in an attempt to isolate the influence of individual
country characteristics on the effects of external inflation shocks on the
variance of domestic core inflation.
What is the LIC effect? The results of the first investigation are presented in
Table 6.1 for equations in which cumulative IRFs were the dependent variable
and in Table 6.2 for equations in which the variance decomposition estimates
were the dependent variable. The first row of each table indicates the coefficient
estimates and significance levels (shown by asterisks) of the LIC dummy when it
is included in a regression with a constant and an EMDE (non-LIC) dummy
only. The subsequent rows show the results of regressions in which additional
variables are included individually. Each row corresponds to a different
regression, which includes not only an LIC dummy, EMDE dummy, and
constant, but also the variable indicated in the row title. It is important to note
that the numeric values and significance levels shown in the table are not those
of the additional included variable, but rather of the LIC dummy. Thus, it is for
cases in which row 1 shows statistical significance and some other row in the
table shows insignificance that it can be inferred that a country characteristic

renders an otherwise significant LIC dummy insignificant when included in the
regression.
The response of core inflation in LICs to global shocks is only statistically

elevated in the case of global food price shocks (Table 6.1). However, global
core price shocks explain 37-39 percentage points more of LIC core inflation
variation than in other regions (Table 6.2). The latter set of results is consistent
with what was noted earlier, in that global inflation shocks appear to make a
larger contribution to the variation in domestic inflation in LICs than in other
EMDEs or advanced economies.
For the transmission of global food-price shocks, several structural characteristics

appear to be important, including dependence on commodity imports, labor
market (or demographic) variables, capital account openness, and trade
openness. The variable indicating the degree of central bank transparency and
independence also appears to play a role. By contrast, for the transmission of
global core price shocks, it was difficult to identify country characteristics that
could explain the LIC dummy. To some extent, the degree of the LIC effect is
influenced by central bank transparency, trade openness, and population
growth, since the inclusion of these variables substantially changed the
magnitude of the regression coefficients, although it did not render the
coefficient on the LIC dummy insignificant. Although these results are not
formal tests of causation, they suggest that the degree of central bank
transparency, trade and capital account openness, as well as demographic
variables are most likely associated with the higher contribution of global
inflation shocks to variations in domestic core inflation in LICs. Further
empirical investigation of the LIC effect is needed to identify the factors that
could render the LIC dummy insignificant. Perhaps, additional structural
characteristics of the economy (for example, industry structure) could help
explain the LIC effect.
How can LICs reduce their vulnerability to global inflation shocks? To

examine how LIC inflation rates respond to global shocks, the previous links are
recomputed for LICs only, and thus without an LIC dummy. The results for
IRFs of domestic core inflation as the dependent variable 1, 6, and 18 months
after the original shock are shown in Table 6.3 and for variance decompositions
as the dependent variable in Table 6.4. The coefficients and significance levels
shown are now those of the variables indicated in the row titles.
The strength of the energy and food price shock transmissions are inversely
associated with increased trade and financial openness as well as increased central
bank transparency. Similarly, the results suggest that the magnitude of the
transmission of the global core shock is negatively associated with increased
TABLE 6.1 Regression of the response of core inflation

Response of domestic core to Global energy Global food Global core
Time horizon (months) 6 18 6 18 6 18
0.01 0.02 0.08** 0.07 0.25 0.22
LIC dummy
[0.65] [0.48] [2.21] [0.77] [0.67] [0.46]
Level of headline inflation (LIC dummy 0.00 0.01 0.07* 0.05 0.62** 0.59
in the inclusion of each level of the
headline inflation variable) [0.14] [0.25] [1.85] [0.58] [2.53] [1.51]
0.05** 0.09** 0.06 -0.05 0.55 0.35

Commodity importer
[2.30] [2.34] [1.38] [-0.48] [1.27] [0.63]
0.00 0.01 0.07* 0.05 0.61** 0.62
GDP
[-0.01] [0.14] [1.75] [0.52] [2.39] [1.53]
0.00 0.00 0.07* 0.06 0.59** 0.65
Inflation target
[-0.1] [0.09] [1.86] [0.69] [2.31] [1.62]
0.00 0.00 0.066* 0.07 0.53** 0.58
Pegged exchange rate regime
[-0.07] [0.12] [1.76] [0.8] [2.09] [1.43]
0.01 0.02 0.05 0.01 0.48* 0.53
Central bank transparency
[0.66] [0.44] [1.13] [0.07] [1.75] [1.21]
0.00 0.00 0.07* 0.07 0.61** 0.60

Public debt
[-0.12] [0.02] [1.91] [0.78] [2.42] [1.53]
0.02 0.02 0.04 0.02 0.39 0.30
Population growth
[0.77] [0.58] [0.89] [0.15] [1.4] [0.67]
0.01 0.02 0.06 0.05 0.391* 0.37
Labor market flexibility
[0.51] [0.51] [1.61] [0.54] [1.86] [1.03]
0.01 0.01 0.04 -0.06 0.90*** 0.86*
Capital account openness
[0.36] [0.31] [0.91] [-0.59] [3.01] [1.8]
0.01 0.01 0.06 0.06 0.67*** 0.51
Trade openness
[0.3] [0.25] [1.63] [0.6] [2.62] [1.28]
Source: Chinn and Ito 2018; Dincer and Eichengreen 2014; International Monetary Fund; World Bank.
Note: Each row corresponds to a different regression, where the coefficients and significances (t-values) are those of the
variable indicated in the row title. The dependent variables are based on a country-specific heterogeneous panel SVAR
estimation for 104 countries (25 advanced economies, 61 EMDEs, and 18 LICs). EMDEs here exclude LICs. GDP is
national GDP measured in U.S. dollars using purchasing power parity (not market) exchange rates. Inflation targeting
regimes are defined as in IMF (2016). Central bank transparency data are based on Dincer and Eichengreen (2014).
Exchange rate regimes are based on Shambaugh (2004). Labor market flexibility is based on the estimates compiled by
the Fraser Institute, with a higher value representing a more flexible labor market. The measures of trade and capital
account openness are, respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled by
Chinn and Ito (2018). Dependent variables are based on mean values over the country-specific sample periods. The
numbers in brackets refer to t-statistics. EMDEs = emerging market and developing economies; GDP = gross domestic
product; LIC = low-income country; SVAR = structural vector autoregression.
*** p < 0.01, ** p < 0.05, *p < 0.1 significance levels.
TABLE 6.2 Regression of variance decompositions of core

inflation
Variance share for domestic core Global energy Global food Global core
Forecasting horizon (months) 6 18 6 18 6 18
0.01 0.03 0.03** 0.02 0.37*** 0.39**
LIC dummy
[0.36] [1.40] [2.04] [1.59] [3.83] [4.19]
Level of headline inflation (LIC dummy
0.00 0.02 0.02* 0.02 0.40*** 0.42**
in the inclusion of each level of the
[0.2] [1.21] [1.88] [1.35] [4.02] [4.38]
headline inflation variable)
0.01 0.02 0.01 0.00 0.34*** 0.38***
Commodity importer
[0.56] [1.03] [0.81] [0.08] [2.96] [3.39]
0.00 0.02 0.02* 0.02 0.35*** 0.38***
GDP
[0.05] [1.01] [1.83] [1.23] [3.51] [3.87]
0.01 0.03 0.02* 0.02 0.32*** 0.34***
Inflation target
[0.42] [1.33] [1.74] [1.28] [3.29] [3.66]
0.01 0.02 0.02* 0.02 0.38*** 0.40***
[0.29] [1.21] [1.65] [1.39] [3.73] [4.08]
0.01 0.03 0.02 0.02 0.25*** 0.29***
[0.29] [1.3] [1.42] [1.04] [2.36] [2.74]
0.01 0.03 0.02* 0.02 0.40*** 0.42***
Public debt
[0.5] [1.5] [1.74] [1.46] [3.95] [4.31]
0.02 0.04* 0.02 0.03 0.24*** 0.26***
Population growth
[0.87] [1.82] [1.53] [1.48] [2.21] [2.53]
0.01 0.03 0.03*** 0.025* 0.36*** 0.38***
[0.5] [1.58] [2.23] [1.71] [3.62] [3.99]
-0.01 0.02 0.01 0.00 0.42*** 0.42***
[-0.28] [0.85] [0.32] [0.02] [3.44] [3.57]
0.01 0.03 0.02 0.01 0.48*** 0.49***
Trade openness
[0.55] [1.46] [1.33] [0.87] [4.88] [5.26]
Source: Chinn and Ito 2018; Dincer and Eichengreen 2014; International Monetary Fund; Shambaugh 2004; World Bank.
Note: Each row corresponds to a different regression, where the regression includes an LIC dummy, an EMDE dummy, a
constant, and the variable indicated in the row title. The numeric values and significance levels (t-values) are not
those of the additional included variable, but rather those of the LIC dummy when the variable indicated in the row title was
included in the regression. Thus, it is cases where row 1 shows significance, and some other row in the table shows
insignificance, that are indicative of a country characteristic that rendered an otherwise significant LIC dummy insignificant
through its inclusion in the regression. The dependent variables are based on country-specific heterogeneous panel SVAR
estimations for 104 countries (25 advanced economies, 61 EMDEs, and 18 LICs). EMDEs here exclude LICs. The LIC
dummy equals 1 for any LIC, and 0 for any other country. GDP refers to national GDP measured in U.S. dollars using
purchasing power parity (not market) exchange rates. Inflation targeting regimes are defined as in IMF (2016). Central
bank transparency data are based on Dincer and Eichengreen (2014). Exchange rate regimes are based on Shambaugh
(2004). Labor market flexibility is based on the estimates compiled by the Fraser Institute, with a higher value representing
a more flexible labor market. The measures of trade and capital account openness are, respectively, trade (exports plus
imports)-to-GDP ratios (in percent) and the index compiled by Chinn and Ito (2018). Dependent variables are based on
mean values over the country-specific sample periods. The numbers in brackets refer to t-statistics. EMDEs = emerging
market and developing economies; GDP = gross domestic product; LIC = low-income country; SVAR = structural vector
autoregression.
central bank transparency.17 Although they are less statistically significant,

the results indicate that higher financial and trade openness is associated with
increased strength in the transmission of global core shocks into core inflation
in LICs.
Therefore, openness measures appear to play different roles for the cumulative
IRFs and variance decompositions of domestic core inflation to global relative
price shocks versus global core price shocks in LICs. It could be that relative
price shocks (for example, shocks in energy and food prices) are mostly driven
by supply shocks, and shocks to global core inflation are largely demand shocks.
Thus, the differential consequences of openness for the transmission of these
shocks into domestic core inflation reflect different channels through which
demand and supply shocks are transmitted. Alternatively, it could also be the
case that global relative price shocks are less destabilizing for domestic inflation
expectations, because opening trade and the domestic financial market to global
markets contributes to the anchoring of inflation expectations as a disciplining
device. It is also possible that the global core price shocks could have different
consequences for domestic core inflation in different groups of LICs, by
interacting with other structural features, for example, exchange rate regimes.18
In sum, from the two types of regression analysis, it seems that the policy
reactions for the LIC effect need not be the same as the causes of the LIC effect,
especially for global core price shocks, which explain the largest portion of
variation in LICs’ core inflation. The exceptions to this might be the degree of
openness and the degree of central bank independence, for the transmission of
global energy and food price shocks. The above results point toward individual
country characteristics that may be significant in helping to account for
differences in the transmission of global shocks to domestic core inflation in
LICs, or in helping to identify which policies might help reduce the magnitude
and variance contribution of these transmissions. The next step is to use these
results as a basis for investigating possible multivariate relationships, especially
interaction effects that help identify policies that may be particularly effective in
anchoring inflation expectations in LICs.
17 The results do not necessarily imply a causal relation from greater central bank transparency to better
anchored domestic core inflation in LICs. Central bank transparency may simply be a proxy for a whole
constellation of institutional factors that may be conducive to better anchoring of core inflation
expectations in LICs (see, for instance, Bordo and Siklos (2017)). The important point is that the usual
policy suspects—such as central bank transparency—appear to have the type of association with the
anchoring of core inflation expectations that might be expected, but of course these results are at best
suggestive.
18 This would be analogous to the observation in Figure 6.5 that shows that different types of shocks
have different consequences for advanced economies and EMDEs, depending on the exchange rate
regimes.
TABLE 6.3 LICs: Regression of the response of core inflation on country characteristics
Response of domestic core to Global energy Global food Global core

Time horizon (months) 1 6 18 1 6 18 1 6 18
0.00 0.01 0.03 0.00 0.01 0.04 -0.02 -0.37 -0.22
Level of headline inflation
[0.99] [0.32] [1.08] [0.02] [0.12] [0.4] [-0.75] [-0.91] [-0.46]
-0.01 -0.05 -0.06 -0.01 0.03 0.01 -0.01 2.20*** 2.23**
Commodity importer
[-0.7] [-1.5] [-1] [-0.54] [0.32] [0.07] [-0.29] [3.21] [2.55]
0.00 0.00 0.003** 0.00 0.00 0.01 0.00 0.02 0.04*
GDP
[1.08] [1.56] [2.42] [1.02] [1.49] [1.58] [-0.8] [0.87] [1.65]
-0.01 0.00 -0.04 0.00 -0.01 -0.06 0.04 0.87 0.63
[-0.89] [-0.1] [-0.79] [-0.07] [-0.14] [-0.35] [1.05] [1.1] [0.65]
-0.010** 0.01 -0.01 -0.02* -0.07 -0.15 0.03 -0.03 -0.16
[-1.98] [0.56] [-0.36] [-1.89] [-1.14] [-1.36] [0.95] [-0.05] [-0.27]
0.00 0.00 -0.05 -0.01 0.01 -0.06 0.03 0.84 0.26
Public debt
[-0.63] [0.1] [-1.14] [-0.66] [0.16] [-0.38] [0.75] [1.34] [0.34]
0.01 -0.02 -0.01 0.01 0.09 0.09 0.01 0.51 0.73
Population growth
[1.07] [-0.57] [-0.09] [0.75] [0.79] [0.44] [0.23] [0.56] [0.68]
0.01 0.01 0.08 0.01 -0.08 -0.15 -0.05 1.26* 2.39***

[0.59] [0.35] [1.41] [0.35] [-0.66] [-0.68] [-1.03] [1.72] [3.02]
0.01 0.06 -0.02 0.00 -0.31* -0.68** -0.01 1.42 0.48
[0.38] [0.94] [-0.18] [-0.03] [-1.82] [-2.2] [-0.17] [0.92] [0.25]
-0.01 0.01 -0.09** -0.02 -0.10 -0.25 0.06* 0.72 -0.18
Trade openness
[-0.94] [0.21] [-2.1] [-1.08] [-1.14] [-1.63] [1.83] [1.02] [-0.2]
Note: Each row corresponds to a different regression, where the coefficients and significances (t-values) are those of the variable indicated in the row title. The dependent variables are based on a country-
specific heterogeneous panel SVAR estimation for 104 countries (25 advanced economies, 61 EMDEs, and 18 LICs). EMDEs here exclude LICs. GDP refers to national GDP measured in U.S. dollars
using purchasing power parity (not market) exchange rates. Inflation targeting regimes are defined as in IMF (2016). Central bank transparency data are based on Dincer and Eichengreen (2014).
Exchange rate regimes are based on Shambaugh (2004). Labor market flexibility is based on the estimates compiled by the Fraser Institute, with a higher value representing a more flexible labor market.
The measures of trade and capital account openness are, respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled by Chinn and Ito (2018). Dependent variables are
CHAPTER 6
based on mean values over the country-specific sample periods. The numbers in brackets refer to t-statistics. EMDEs = emerging market and developing economies; GDP = gross domestic product; LICs
= low-income countries; SVAR = structural vector autoregression.
345
346
TABLE 6.4 LICs: Regression of the variance decompositions of core inflation on country characteristics
Variance share of Global energy Global food Global core

Forecasting horizon (months) 1 6 18 1 6 18 1 6 18
0.00 0.00 0.00 0.00 0.01* 0.00 -0.02 0.06 0.02
Level of headline inflation
[0.99] [0.35] [-0.46] [0.02] [1.69] [-0.2] [-0.75] [0.63] [.1.14]
CHAPTER 6
0.00 0.00 0.00 -0.01 -0.01 0.00 -0.01 0.24 -0.01

Commodity importer
[-0.71] [-0.06] [0.15] [-0.54] [-0.75] [-0.41] [-0.29] [1.32] [-0.25]
0.00 0.00 0.00 0.00 0.001*** 0.00 0.00 0.01** 0.00
GDP
[1.08] [0.50] [0.72] [1.02] [2.61] [0.95] [-0.8] [2.47] [0.76]
-0.01 0.00 0.00 0.00 -0.02 0.00 0.04 0.01 -0.04
[-0.89] [-0.17] [0.11] [-0.07] [-1.27] [0.53] [1.05] [0.04] [-1.27]
-0.006** 0.00 0.00 -0.02* -0.01 0.00 0.02 -0.23** -0.01
[-1.98] [-0.06] [-0.78] [-1.89] [-1.38] [-0.54] [0.95] [-2.41] [-0.63]
0.00 -0.01 0.00 -0.01 0.00 0.00 0.02 -0.12 -0.01
Public debt
[-0.63] [-1.3] [-1.44] [-0.66] [-0.21] [0.78] [0.74] [-0.86] [-0.26]
0.01 0.00 0.00 0.01 0.01 0.01 0.01 0.28 0.02
Population growth
[1.07] [-0.19] [-1.09] [0.75] [0.71] [1.41] [0.24] [1.5] [0.42]
0.00 -0.01 0.00 0.01 0.00 0.00 -0.05 0.46*** 0.08**
[0.58] [-0.86] [0.23] [0.34] [-0.11] [-0.14] [-1.03] [2.64] [2.38]
0.00 -0.06*** -0.01** 0.00 -0.03 0.02 -0.01 0.12 0.11*
[0.37] [-3.59] [-2.04] [-0.03] [-0.75] [1.33] [-0.17] [0.34] [1.84]
0.00 -0.01 -0.01** -0.01 -0.03** 0.01 0.06* -0.22 -0.02
Trade openness
[-0.92] [-1.31] [-2.23] [-1.08] [-2.15] [0.96] [1.83] [-1.44] [-0.84]
Note: Each row corresponds to a different regression, where the coefficients and significances (t-values) are those of the variable indicated in the row title. The dependent variables are based on a country
-specific heterogeneous panel SVAR estimation for 104 countries (25 advanced economies, 61 EMDEs, and 18 LICs). EMDEs here exclude LICs. GDP refers to national GDP measured in U.S. dollars
using purchasing power parity (not market) exchange rates. Inflation targeting regimes are defined as in IMF (2016). Central bank transparency data are based on Dincer and Eichengreen (2014).
Exchange rate regimes are based on Shambaugh (2004). Labor market flexibility is based on the estimates compiled by the Fraser Institute, with a higher value representing a more flexible labor market.
The measures of trade and capital account openness are, respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled by Chinn and Ito (2018). Dependent variables are
based on mean values over the country-specific sample periods. The numbers in brackets refer to t-statistics. EMDEs = emerging market and developing economies; GDP = gross domestic product; LICs
= low-income countries; SVAR = structural vector autoregression.
How do the effects of country characteristics differ in LICs from other country
groups? The presence of an “LIC effect” was explored further by using data for
all country groups to examine whether the values of the dependent variable differ
systematically for LICs. The results indicate that for LICs and other EMDEs, the
share of the 18-month variance in domestic core inflation explained by global
core inflation is much higher than for advanced economies, although not greatly
different between these two groups (Table 6.5).
Next, the robustness of these differences to the inclusion of other variables was
examined. The initial results suggested that the various cross-country differences
could affect the transmission of global core inflation to domestic core inflation.
Accordingly, the variables capturing trade and financial openness, exchange rate
regime, and central bank transparency were included in the regressions, one at a
time (columns 2 through 4 of Table 6.5). However, none of these variables
made a significant difference. The coefficients on the EMDE (non-LIC) and
LIC dummies were essentially unaffected, and none of the additional variables
was statistically significant (to save space, these results are not reported). Instead,
in column 5, all the variables were included together. Again, none was
statistically significant, and the coefficients on the dummies were unaffected.
These results suggest that the differences between LICs and other EMDEs, on
the one hand, and advanced economies on the other, are not due to systematic
differences among these sets of countries with respect to the characteristics most
naturally suggested by theory.
The next question considered was whether the different inflation performance of
LICs and other EMDEs, relative to advanced economies, is attributable to
differences in the effects of the relevant characteristics on the transmission from
global to domestic core inflation between LICs and other EMDEs, on the one
hand, and advanced economies on the other. This question was explored by
interacting these characteristics with the EMDE and LIC dummies, one at a
time. If the interaction term is statistically significant, the implication would be
that the EMDE or LIC context makes a difference in the role of the relevant
characteristics. This was not the case for either of the openness variables (the
results are not reported here). However, the exchange rate regime made a
substantial difference, as shown in columns 6 and 7 of Table 6.5. The
interaction of the pegged exchange rate regime variable, pegged XR, with the
EMDE and LIC dummies proved highly significant in both cases, but with
opposite signs. Fixed exchange rates thus had a substantial negative effect on
transmission from the global to the domestic core in LICs, but a modest positive
effect in other EMDEs.
The implications are that the “EMDE effect” and “LIC effect” are regime-
specific. For illustrative purposes, if Pegged XR is set to 0 for countries with
floating rates and Pegged XR is set to 1 for countries with fixed rates, the EMDE
effect (column 6 in Table 6.5) would be 0.39 for floating regime countries and
0.59 for fixed regime countries; for LICs, the corresponding values are 0.67 and
0.04, respectively. Focusing specifically on the LIC results, the upshot is that
LICs that fix their exchange rates seem to be able to anchor inflation
expectations about as well as advanced economies, and those that float are not
able to do so. This result is consistent with the view that LICs have found it
difficult to generate homegrown anchors for the domestic core.
To investigate this issue, the possible role of central bank independence in

anchoring inflation expectations among LIC floating regime countries was
considered. This was done by interacting a measure of central bank
independence, central bank turnover, with exchange rate flexibility (1 – Pegged
XR) in LICs.19 The results are reported in column 7 of Table 6.5. The
interaction term is not significant at conventional levels, but, in view of the
small number of floating regimes among the LICs in the sample, the p-value of
0.27 makes the negative coefficient at least suggestive: LICs that float may be
more successful at anchoring inflation expectations in the face of shocks to
global core inflation when their central banks are more independent.
Conclusion
There has been a remarkable degree of convergence of views in academic and
policy circles about the principles to which monetary policy should adhere to
yield the low and stable medium-term inflation that is conducive to healthy
economic growth. However, central banks in LICs face significant challenges in
achieving low and stable inflation and anchoring inflation expectations to such
an outcome. Meanwhile, globalization has proceeded apace in LICs, as it has
elsewhere, affecting, through several channels, the challenges confronted by LICs
in achieving this objective.
Nevertheless, over the past two decades, inflation rates in LICs have been
declining, from excessively high levels in many cases, and have converged closer
to those of advanced economies and other EMDEs, despite the special
challenges faced by LICs. These challenges include sizable domestic shocks, as
well as large external shocks, which increasing globalization may have amplified.
At the same time, inflation has stabilized at a low rate in the large advanced
economies. The improvement in LIC inflation performance over the past two
decades raises the question of the extent to which it reflects an improved
domestic policy environment (that is, homegrown) or has effectively been
19 The Central bank turnover measures central bank turnover rates, the number of changes in central
bank heads before the end of the legal term of office, as in Dreher, Sturm, and de Haan (2010). This
variable is used here instead of central bank transparency and independence, for wider country coverage
of the data.
TABLE 6.5 Regression of the variance of core inflation explained by

global core price shocks on country characteristics
Variables 1 2 3 4 5 6 7
0.49*** 0.50*** 0.49*** 0.49*** 0.49*** 0.39*** 0.39***
EMDE dummy
[0.00] [0.00] [0.00] [0.00] [0.00] [0.00] [0.00]
0.38*** 0.39*** 0.38*** 0.38*** 0.38*** 0.67*** 0.80***
LIC dummy
[0.00] [0.00] [0.00] [0.00] [0.00] [0.00] [0.00]
0.001 0.001 0.0002 0.0001
Trade openness
[0.28] [0.34] [0.73] [0.86]
-0.004 -0.03 -0.09 -0.07
[0.97] [0.78] [0.47] [0.48]
Pegged exchange rate 0.04 0.03

regime (Pegged XR) [0.61] [0.71]
0.20** 0.20***
Pegged XR*EMDE
[0.04] [0.04]
-0.63*** -0.76***
Pegged XR*LIC
[0.00] [0.00]
CB turnover* -0.81
(1-Pegged XR)*LIC [0.26]
R2 0.36 0.37 0.36 0.36 0.37 0.46 0.46
Source: Chinn and Ito 2018; Dreher, Sturm, and de Haan 2010; International Monetary Fund; Shambaugh 2004; World
Bank.
Note: Each column corresponds to a different regression. The dependent variables (the variance share of global core
shocks for domestic core inflation at the 18-month forecasting horizon) are based on a country-specific heterogeneous
panel SVAR estimation for 104 countries (24 advanced economies, 61 EMDEs, and 18 LICs). EMDEs here exclude LICs.
The LIC dummy equals 1 for any LIC and 0 for any other country. The EMDE dummy equals 1 for any EMDE and 0 for any
other country. CB turnover refers to the number of changes in the head of a central bank before the end of a legal term of
office, based on Dreher, Sturm, and de Haan (2010). Because of the wider availability of data for this variable, it is used
instead of central bank transparency. Exchange rate regimes are based on Shambaugh (2004). The measures of trade and
capital account openness are, respectively, trade (exports plus imports)-to-GDP ratios (in percent) and the index compiled
by Chinn and Ito (2018). Dependent variables are based on mean values over the country-specific sample periods. The
numbers in brackets refer to p-values. CB = central bank; EMDEs = emerging market and developing economies; GDP =
gross domestic product; LICs = low-income countries; SVAR = structural vector autoregression; XR = exchange rate.
imported. It is difficult to take a firm view on this question ex ante, because

globalization has affected the challenges faced by LIC central banks in
complicated ways that do not unambiguously make their anti-inflation
objectives easier or more difficult to achieve.
The question must therefore be approached empirically. The heterogeneous

panel SVAR technique used for this chapter has allowed us to assess the relative
roles of the external inflation environment and domestic factors in driving core
inflation in a large group of countries, including LICs and other country groups.
The inclusion of other countries provides better estimates of the influence of
relevant global factors and the roles of different country characteristics in

explaining the susceptibility of domestic core inflation to being dislodged by
external shocks. Compared with the existing literature, the results of the analysis
in this chapter lead to some new conclusions.
• LIC core inflation tends to respond more strongly to global core inflation
than does core inflation in the other country groups.
• LIC core inflation responds more strongly to global food inflation than does
core inflation in the other country groups.
• LIC core inflation responds more sharply, although more variably, to global
energy inflation than does core inflation in the other country groups.
• Exchange rate pass-through to core inflation also appears to be much larger

for LICs than for the other country groups.
Together, these results suggest that, at least in this sample, core inflation was
more susceptible to external disturbances in LICs than in the other country
groups. Variance decompositions support this result, indicating that most of the
variation in domestic core inflation among LICs was accounted for by external
inflation shocks, and very little by shocks to domestic core inflation, a result
exactly opposite of that of advanced economies.
What sets LICs apart is not so much that they differ from advanced economies
(and other EMDEs) in characteristics that might be expected to contribute to
importing global inflation, such as trade or financial openness or the exchange
rate regime. Rather, it is that these characteristics appear to operate differently in
the LIC environment.
Thus, LICs with floating exchange rates have had a difficult time stabilizing
inflation at a low rate, although they seem to resist external inflation shocks
better when their central banks are more independent. In contrast, LICs that fix
their exchange rates seem to be able to succeed in stabilizing core inflation about
as well as advanced economies, suggesting that these LICs might have, in

essence, imported anti-inflation credibility. This result reflects the economic
principle that a fixed exchange rate against a low-inflation currency is a
monetary standard in which the foreign central bank provides the nominal
anchor.
A flexible exchange rate regime, in contrast, is on its own monetary standard: a

domestic nominal anchor must stabilize inflation expectations. A popular, and
robust, choice for the latter in this century—for many EMDEs as well as
advanced economies—is to set an explicit medium- and long-term inflation
target for monetary policy (Adrian, Laxton, and Obstfeld 2018). In this
regime, the flexible exchange rate provides an important means of adjustment to
real sector shocks, which facilitates the robustness of the regime. Fixed exchange
rate regimes, in contrast, have often proven fragile, and are prone to collapse.
These factors underline the need for a reform agenda to strengthen the anti-
inflation credibility of domestic monetary policy.
The upshot is that LIC central banks do not yet appear to have been sufficiently
successful in meeting the challenges posed for them by the environment in
which they operate, and they have not yet achieved the objective of securing low
and stable medium-term inflation rates on a homegrown basis. Instead, the
results in this chapter suggest that their much-improved inflation performance
might have largely been imported. Consequently, if global inflation were to rise,
LICs would likely see their inflation rising in tandem. Hence, the reform agenda
for achieving homegrown anti-inflation credibility in LICs remains unfinished.
The chapter raises some questions. The implications for inflation outcomes of
differences in the characteristics of LICs and other EMDEs remain to be
explored. Of immediate policy relevance are questions related to reforms of LIC
central banks to achieve homegrown anti-inflation credibility. Given the
challenging operating environments for LIC central banks, these may well differ
from reform priorities elsewhere. Finally, it would be useful to study changes in
the transmission of global shocks into LICs.
ANNEX 6.1 Monetary policy challenges

in low-income countries
The level and volatility of inflation in low-income countries (LICs) have remained
higher than in advanced economies and other emerging market and developing
economies over the recent two decades. This divergence may partly reflect special
monetary policy challenges that arise in LICs from their volatile economies, conflicts
among central bank policy objectives, weaknesses in monetary policy transmission,
and limited institutional capacity at central banks. There are various ways in which
these challenges may be addressed.
Introduction: The role of monetary policy and its recent

performance in low-income countries
Central banks around the world accept that they serve two primary objectives:
price stability, meaning low and stable inflation, and financial stability, meaning
maintenance of a financial system that is safe and sound (Taylor 2005;
Hammond, Kanbur, and Prasad 2009). To achieve their objectives, central
banks have two sets of policy instruments. One comprises the instruments of
monetary policy, which are used to exert control over the general level of interest
rates, particularly short-term rates, and the supply of credit. The other comprises
prudential regulation and supervision, including capital requirements applying
to financial institutions and constraints on their lending, which are sometimes
referred to as macroprudential policies. There is today broad consensus that the
instruments of monetary policy are generally best assigned to the objective of
price stability, and prudential policies are generally best assigned to the objective
of financial stability (Bernanke and Gertler [1999] and many others).
The primary objective of monetary policy is therefore low and stable inflation.
This refers more to the medium term rather than the short term, since short-
term fluctuations in inflation are unavoidable and of limited importance.
In recent decades, there has been substantial progress in many countries, and
globally, toward price stability, with inflation having been lowered considerably
from the relatively high levels reached in the 1970s and 1980s. Between 2000
and 2016, the inflation level more than halved in advanced economies and
emerging market and developing economies (EMDEs) (excluding low-income
countries [LICs]), and inflation volatility has also decreased (Figure 6.1).1
Despite the global downward trend in the level and volatility of inflation,
progress has been less pronounced in LICs. Although headline and core
1 This trend has continued in recent years. Median consumer price inflation has fallen significantly in
EMDEs, to 3.5 percent in 2017, from 5.5 percent per year, on average, in the decade before the global
financial crisis. In contrast, median inflation in LICs was 5 percent in 2017, barely changed from the 6
percent average in 1999-2008.
consumer price inflation levels in LICs are still higher than those in advanced
economies, the volatility has remained much higher than in advanced economies
and other EMDEs (Figure 6.1). It seems that monetary policies in LICs, overall,
have not been so successful in recent years for the objective of low and stable
inflation, despite a global environment conducive to this aim.
This may be due partly to the particular challenges faced by monetary policy in
LICs. These are the subject of this annex, which asks two questions:
• What have been the challenges facing monetary policy in LICs?
• How can the challenges be addressed?
What have been the challenges facing monetary policy in LICs?
A key factor in determining the ability of central banks to achieve low and stable
inflation is their success in anchoring the inflation expectations of wage and
price setters. If expectations are well anchored at a low inflation rate, temporary
departures of inflation from this level will be less likely to set inflation
expectations adrift and have prolonged effects on the inflation rate. Inflation
expectations are shaped importantly by the credibility of the central bank, which
depends partly on the clarity of its stated objectives, and partly on its
demonstrated commitment to its objectives and ability to achieve them (Blinder
et al. [2008], among many others). These considerations point to several
challenges facing monetary policy in LICs.
One challenge is simply that the history of inflation in LICs is unfavorable for
establishing confidence in future price stability. LICs therefore face more of a
challenge than advanced economies in establishing a convincing track record of
low and stable inflation.
More fundamentally, monetary policy in LICs faces challenges arising from
conflicts among policy objectives, difficulties in specifying appropriate policy
objectives, weaknesses in the instruments and transmission mechanism of
monetary policy, and shortcomings in the analytical capacity of central banks.
These are considered in turn.
Conflicts among policy objectives

There are several reasons why it may be more challenging in LICs than in
advanced economies and many other EMDEs for central banks to focus their
policies on the objective of low and stable inflation.
First, because LICs start with relatively high inflation, it is more difficult for a
central bank to make a credible commitment to low and stable inflation.
This commitment will require the central bank to be willing to tolerate
relatively weak activity—negative output gaps—perhaps for an extended period,
which will conflict with its secondary objectives (Kasa 2001; Gemayel, Jahan,
and Peter 2011).
Second, in LICs there tend to be relatively more frequent supply shocks than in
other country groups, arising, for example, from the effects of weather events on
agricultural production (Frankel 2011). A poor harvest will tend to increase
inflation in the short term while depressing economic activity. Supply shocks
thus push inflation and output growth in opposite directions, tending to give
rise to a conflict between monetary policy’s primary objective of stabilizing
prices and its secondary objectives of supporting growth and maintaining a
narrow output gap. Stabilizing inflation in response to supply shocks may thus
require the sacrifice of the secondary objectives of monetary policy (Nguyen et
al. 2017; Adam 2011; Bashar 2011). This contrasts with demand shocks, which
are relatively less prevalent in LICs than in other country groups, where
stabilizing inflation should simultaneously serve the objective of containing
output and employment gaps (“divine coincidence”) (Blanchard and Galí 2007).
Third, central banks in LICs are more likely to face conflicts between price
stability and fiscal considerations, including the demands of the authorities’
fiscal policy (Mas 1995; Prasad 2010). Because they are public sector
institutions with the capacity to generate seigniorage revenue through the
issuance of interest-free liabilities (most notably, currency), central banks can
face pressures to provide cheap financing to governments. These pressures will
tend to be greater in LICs, because systems for raising revenue from taxes are
relatively less well developed. In the extreme case of fiscal dominance, in which
the central bank is institutionally subservient to the finance ministry, meeting
the demands of fiscal policy becomes the bank’s overriding objective, regardless
of its adverse consequences for price stability.
Endowing central banks with legal independence has become more prevalent
since the early 1990s, partly as a means to allow central banks to give primacy to
price stability over fiscal objectives and enhance their anti-inflation credibility.
However, such de jure independence does not necessarily translate into de facto
independence. Researchers have constructed measures of the latter based on
various indicators, including for EMDEs (for example, Cukierman 2008;
Garriga 2016). One study found that although central bank independence
increased around the world with reforms undertaken from the early 1990s,
EMDEs and the subgroup of LICs remained characterized by less independent
central banks than did advanced economies (Garriga 2016).2
2 Garriga’s index of independence, which theoretically ranges from 0 (least independence) to 1 (most
independence), averaged 0.71 for 34 advanced economies, 0.57 for 110 EMDEs, and 0.62 for 26 LICs.
But even independent central banks may find their commitment to price
stability undermined by fiscal constraints. To the extent that a central bank
depends on the finance ministry to recapitalize it if it incurs large losses, it may
be more receptive to government pressure; and to safeguard its independence in
light of this possibility, it may abstain from policies that would require it to
incur sustained losses (most notably the sterilization of capital inflows), even if
by doing so it endangers price stability. Furthermore, a central bank may find its
pursuit of price stability constrained by fiscal considerations even in the absence
of concern for its own solvency. For example, when the government’s solvency is
itself precarious, the central bank may be reluctant to pursue anti-inflation
policies that would increase the government’s borrowing costs and reduce tax
revenues.
Therefore, there are several ways in which fiscal considerations can constrain
central banks’ policies in pursuit of price stability and undermine their anti-
inflation credibility in LICs.
Fourth, in LICs (as in some other EMDEs) the exchange rate may be a more
important policy objective than it is in advanced economies (Taylor 2001;
Mishkin and Savastano 2001; Buffie et al. 2004; IMF 2015). A declared strategy
of stabilizing the nominal exchange rate against one or more currencies of
trading partners that have a track record of low and stable inflation may well be
compatible with the achievement of domestic price stability. Indeed, for some
LICs, such a strategy may offer a particularly effective way to achieve this
objective. Given the limited international financial integration of many LICs,
the adoption of such an exchange rate peg may leave some scope for monetary
management directed toward domestic objectives. For many LICs, therefore,
monetary and exchange rate policies may remain potentially independent, as
noted by Ostry, Ghosh, and Chamon (2012). This contrasts with advanced
economies and many EMDEs that are highly integrated with international
financial markets, where the open-economy trilemma implies that it would be
impossible to maintain independent monetary and exchange rate policies.
However, conflicts between monetary and exchange rate policies may arise.
Thus, an ad hoc assignment of monetary policy to an objective of exchange rate
stabilization—motivated, for example, by currency mismatches in balance sheets
that mean that depreciation of the domestic currency would increase debt
burdens—may be attempted when important preconditions (relating, in
particular, to international cost competitiveness and inflation differentials) are
not met. Such an effort is likely to prove unsustainable and disruptive and a
distraction from monetary stabilization. In such cases, it would be more
advisable to address the causes of the balance sheet mismatches, including
shortcomings in financial regulation, although constraints on official borrowing
in domestic currency (associated with “original sin”) may be difficult to address

in the short term (Calvo and Reinhart [2002], among many others).
There may also be an inclination in LICs, as in other EMDEs, to adopt the real
exchange rate as a policy objective. As argued by Rodrik (2007) and Berg and
Miao (2010), the real exchange rate may have an important role to play in
development policy through its impact on the traded/nontraded composition of
domestic real output and, in particular, as a means to promote export-led
growth. Thus, LIC central banks may be led to include a depreciated real
exchange rate target among their objectives. But attempting to use monetary
policy to serve this objective will not only distract from the objective of price
stability, but also be destabilizing for inflation. Thus, a domestic inflation shock
will call for monetary policy to be eased to generate a depreciation of the
domestic currency that stabilizes the real exchange rate; but the original inflation
shock will consequently be magnified.
The upshot is that central banks in LICs may be faced with a broader set of
objectives than those in advanced economies.3 Distraction from the primary
objective of monetary policy—price stability—by its secondary aims (supporting
employment and growth), fiscal considerations, or the aim a depreciated real
exchange rate will typically call for more expansionary monetary policies than
the central bank would otherwise pursue.
Difficulties in specifying appropriate policy objectives
The anchoring of inflation expectations depends on more than the central
bank’s commitment to the broad objective of low and stable inflation. It is also
likely to require a declared, quantitatively specific inflation objective for the
medium term that has public support, and against which the public can judge
the central bank’s performance.4
However, specification of an inflation objective may prove relatively challenging
in LICs. It is unlikely that simply importing the inflation targets of advanced
economies (about 2 percent per year) would be optimal for LICs. There are
3 A recent survey of International Monetary Fund country desks for 44 LICs and 21 lower-middle-
income countries found that, although price stability was an important objective of monetary policy in
around four-fifths of the countries, more than two-thirds of the central banks were charged with two or
more objectives (IMF 2015). The definition of LICs in the paper differs from the one used in this
chapter.
4 In the past, particularly in the 1970s and 1980s, “intermediate targets” for the growth of monetary
aggregates were widely used, especially by advanced economies, in attempts to anchor inflation
expectations. This strategy encountered several difficulties, including significant differences in the
behavior of various aggregates; difficulties encountered by central banks in controlling the aggregates; and
instability of relationships between the aggregates and economic developments, including inflation.
Monetary aggregates are still monitored by central banks, but reliance on them is now limited and
monetary targets play a small role.
grounds for believing that official inflation objectives in LICs should be

somewhat higher than in advanced economies.
First, the weakness of formal tax systems in LICs, and the high collection costs
frequently associated with them, point to the argument for a larger relative role
of seigniorage as a source of government revenue, particularly from the relatively
large informal sector, where tax collection is limited (Huang and Wei 2006; Di
Bella et al. 2006). However, the argument for a larger role for seigniorage
revenue, and therefore a higher optimal inflation rate than in advanced
economies, depends partly on the productivity of public sector spending. Where
there are grounds for believing that public sector spending yields a particularly
high marginal social rate of return (for example, in areas such as health and
education), the social value of marginal government revenue to finance these
outlays will be high, suggesting a greater role for seigniorage revenue and
therefore a higher optimal inflation rate than in countries where such marginal
social returns are lower. This is one reason why appropriate inflation objectives
will tend to vary from country to country.
Second, there is empirical evidence that higher inflation begins to exert negative
effects on economic growth at significantly higher inflation rates in EMDEs
than in advanced economies (for example, Khan and Senhadji 2001), with
significant variation in the effects among individual countries.
These considerations suggest that the challenge is to identify appropriate
country-specific inflation objectives. The specification of inflation objectives has
indeed proven to be a challenging task for central banks in LICs. The survey of
International Monetary Fund (IMF) country desk economists reported in IMF
(2015) found that most low- and lower-middle-income countries that listed
price stability as a central bank objective, but that had not adopted formal
inflation targeting, did not have a numerical inflation target, and those that had
such a target simply tended to align it with the bank’s inflation forecast.5
To the extent that central banks in LICs have objectives in addition to low and
stable inflation, such as small output or employment gaps, these will also need
to be quantified. This too may pose serious challenges for LICs. Estimation of
output and employment gaps, and of appropriate objectives for them, is highly
problematic in advanced economies, because of instability in the relationship
between unemployment and inflation and uncertainty surrounding estimates of
potential output. It is likely to be even more so in LICs, for example, because of
the higher incidence of supply shocks and the greater prevalence and variability
of underemployment.
5 Again, this is a different set of countries from the group of LICs used in this chapter.
Weaknesses in the instruments and transmission mechanism of monetary policy
In advanced economies and many of EMDEs, the key (conventional) monetary

policy instrument is a very short-term interest rate, most often an interbank rate
such as the federal funds rate in the United States. The central bank can exert
close control over the interbank rate through its supply of reserves to the
banking system and administration of standing facilities. In LICs, however,
interbank markets are typically absent, as are liquid secondary markets in
government securities, which the central bank could seek to influence through
open-market operations. The government securities market in LICs tends to be
a primary market in which the counterparties to the central bank are commercial
banks that adopt a buy-and-hold strategy for such securities. Thus the central
bank conducts monetary policy by directly lending to and borrowing from the
commercial banking system (for example, through repo transactions) or by
doing so indirectly through the primary market for government securities. These
transactions operate by altering the cost of official funds for the banking system.
Thus, in LICs monetary policy heavily depends on the bank lending channel,
and it is typically not activated through an interbank market. Other channels of
transmission that are operative in advanced economies, including through
interest rates on traded securities, exchange rates, and asset prices, are much
weaker in LICs (Mishra, Montiel, and Spilimbergo 2012). This reflects the
absence of highly liquid markets for privately issued traded securities; weak links
with international financial markets, coupled with relatively inflexible exchange
rates; small and illiquid markets for equities; and poorly organized real estate
markets.
The strength and reliability of the bank lending channel are therefore
particularly important in LICs. But they tend to be limited by several factors.
First, LICs are generally characterized by limited financial inclusion and
relatively small formal financial sectors that have only weak links to economic
activity in the important informal sectors of the economy. Second, the
institutional and legal environment in these economies—including property
rights, accounting and disclosure standards, and contract enforcement—tends to
be relatively weak (see, for example, Beck, Demirgüç-Kunt, and Levine [2009]
on LICs in Sub-Saharan Africa). This makes financial intermediation from
private savers to private borrowers costly and risky, inducing banks to limit this
activity and prefer holding safer government securities. Third, productive
activity in these economies is often dualistic, characterized by a few large, well-
established firms and many very small, opaque, and often unstable ones. The
marginal cost of bank lending to large firms tends to be relatively low despite the
imperfections in the domestic institutional environment. But the marginal cost
of extending credit to small firms is likely to rise steeply, so that the volume of
lending to such firms may be very insensitive to fluctuations in bank funding
costs induced by monetary policy. In short, Tobin’s description of the effects of

easing monetary policy under conditions of high liquidity preference as
“pushing on a string” may be an especially apt analogy in the case of LICs, and
the effects of tightening policy are also likely to be limited. A survey of studies of
the strength and reliability of monetary transmission in LICs, by Mishra and
Montiel (2013), and the empirical evidence based on a large panel of countries
by Mishra et al. (2014) are consistent with this perspective.
The challenges created for monetary policy by weak monetary transmission

could conceivably be overcome if the strength of monetary policy effects on such
variables as inflation, real output, and the exchange rate could be reliably
estimated, since weak effects could be offset by stronger policy measures.
However, the strength of monetary transmission in LICs has proven difficult to
estimate because of data limitations (Li et al. 2016). Several investigators have
focused more narrowly on the extent of pass-through from policy rates to bank
lending rates. Saborowski and Weber (2013), for example, find that although
changes in policy rates tended to be transmitted almost one-for-one into retail
bank lending rates in advanced economies, pass-through in developing countries
was only in the range of 30-45 percent. Abuka et al. (2015) find similar evidence
for Uganda in relation to advanced economies, and that pass-through was
particularly weak in less financially developed Ugandan districts. But they find
evidence that increases in policy rates were associated with a reduced supply of
bank credit, suggesting that a bank lending channel was operative in Uganda,
although it was weaker than in advanced economies.
Shortcomings in the analytical capacity of central banks
Because monetary policy affects the economy with lags, an important

component of inflation targeting—or, for that matter, any other activist
monetary policy regime—is the ability of the central bank to forecast with a
modicum of accuracy its target variables on the assumption of unchanged
policies as well as to assess the effects on those variables of potential changes in
the settings of its instruments. In many advanced economies and non-LIC
EMDEs, these tasks are performed using structural macroeconomic models of
the economies in question. However, few LIC central banks have such models
with proven track records (IMF 2015). Although work on such models is
underway at many LIC central banks, the task is formidable, not least because of
the lack of relevant historical data, insufficient knowledge about the
macroeconomic structure of the economies concerned, rapid structural change
in the economy, and shortages of research expertise.
The analytical capacity of LIC central banks—even their ability to monitor and
assess recent and current economic developments—is generally hampered by
serious data deficiencies (Gemayel, Jahan, and Peter 2011; IMF 2015). Thus,
data on economic developments in informal sectors, which are often large, are
typically absent or grossly inadequate. Official estimates of real gross domestic
product (GDP) are typically available only with annual frequency and often
with substantial lags.6 Labor market data, including on wages and
unemployment rates, are generally poor. The absence of a well-defined term
structure of yields in financial markets makes it difficult to assess market
expectations of future monetary policy actions. Finally, estimates of inflation
expectations are generally unavailable because of the absence of survey evidence
and market-based measures derived from differences between yields on
comparable indexed and non-indexed securities.
Complications introduced by globalization
Finally, globalization changes the environment in which LIC central banks

operate in significant ways, both aggravating and easing the challenges they face
in attaining their objectives. Consider four aspects of globalization:
• Increasing size of the domestic traded goods sector.
• For many LICs, increasing volume of inflows of workers’ remittances.
• Larger presence of foreign-owned banks in the domestic economy.
• Increased (although still limited) integration with the international financial

market.
Understood in this way, globalization has several effects on the environment in

which LIC central banks operate. First, globalization is likely to alter the
stability properties of the domestic economy in complicated ways. It increases
the economy’s exposure to external shocks, in the form of exogenous changes in
the foreign-currency prices of traded goods, remittance flows, and capital flows.
Larger remittance flows, for instance, simultaneously magnify the channels of
transmission from the international real economy to domestic aggregate
demand.7 Second, globalization may alter the trade-offs the central bank faces
6 Berg et al. (2015) report that only 13 of the 45 Sub-Saharan African countries in IMF databases
have any quarterly data for GDP, and only five have data on nominal and real GDP. For those with
quarterly data, the median span of the data is less than nine years. As an indicator of measurement error
for real GDP in LICs, Ley and Misch (2014) compare the final estimates of real GDP for a particular
year, as available five years later, to the estimates made by IMF staff in the spring after the year in
question. They find that differences were twice as large for LICs as for Organisation for Economic Co-
operation and Development countries.
7 By estimating a dynamic panel model over 1970-2007, Arusha and Debdulal (2013) document that
international remittance inflows decrease with home country volatility.

between competing objectives. Although most LICs remain poorly integrated

with international financial markets, international financial shocks will
increasingly pose challenges for central banks in LIC economies as well,
especially in the form of destabilizing central bank objectives such as high levels
of economic activity, stable exchange rates, and financial sector robustness. This
will make the potential conflicts between such objectives and the central one of
achieving medium-run price stability potentially more acute. Third,
globalization may affect the monetary transmission mechanism in several ways
(Abuka et. al. 2015; Montiel and Pedroni 2018). Much research has found a
link between individual bank characteristics and the extent to which those banks
tend to pass through changes in policy interest rates to their own retail lending
rates.8 More generally, globalization may also affect the relative merits of
alternative exchange rate and monetary policy regimes in LICs. For instance, a
larger traded goods sector increases the effectiveness of fixed exchange rates in
importing anti-inflation credibility, because a larger share of the domestic price
level is directly affected by international goods arbitrage.
How can these challenges be addressed?
Many of the challenges discussed above are related to the stage of economic and
financial development of LICs and should be addressed as part of the broader
development process. These include the development of financial markets that
may be expected to provide the central bank with more effective policy
instruments, the improvement of systems for the compilation of economic
statistics, and capacity development in central banks and economic ministries,
including strengthening economic expertise.
The focus here, however, is on the issue of conflicts among policy objectives—a
potentially serious obstacle to a central bank’s success in maintaining price
stability and achieving anti-inflation credibility. How can this be addressed?
There are several promising options for LICs.
First, the central banks need to pay attention to the secondary objectives of its
monetary policy—particularly employment and the output gap—which could
be alleviated by the authorities’ use of other economic policies. These could
include the judicious use of budgetary policy when there is fiscal space, and
structural reforms that reduce the economy’s vulnerability to shocks, strengthen
automatic fiscal stabilizers, increase the flexibility and effectiveness of
discretionary fiscal policy, and increase the flexibility of labor markets.
8 For example, Abuka et al. (2015) find that better-capitalized banks in Uganda were less likely to pass
through changes in policy rates. Since foreign banks tend to differ from domestic banks along many of
the relevant dimensions, the changing composition of the domestic banking system associated with
foreign bank penetration is likely to affect aggregate pass-through.
Second, the central bank could develop or strengthen instruments separate from
monetary policy to address its objective of financial stability, including capital
flow management measures and macroprudential policies.
Third, entrusting a large part of the responsibility for financial stability to a

supervisory and regulatory authority, separate from the central bank and
associated with a well-capitalized deposit insurance agency, could relieve
pressure on the central bank to concern itself with financial stability in the
conduct of monetary policy.
Finally, the central bank could strengthen its efforts to convince the public of
the primacy it gives to the low-inflation objective, in ways discussed by Mishkin
(1997). Declaration of a specific inflation target—the strategy adopted by most
advanced economies—could serve this purpose, but this strategy may not yet
suit LICs, for various reasons. These include weak and uncertain monetary
transmission, data deficiencies, and limited analytical capacity at central banks.
For economies with weak anti-inflation records and credibility, like many LICs,
a more effective option could be to peg the exchange rate to a currency or basket
of currencies of one or more trading partners with well-established records of
low inflation. In effect, the central bank would be piggybacking on the low-
inflation credibility earned by these other countries. This would necessarily be at
the cost of a loss of monetary autonomy—the central bank would be “tying its
hands”—if the economy is well integrated with international financial markets.
This may not be a major concern for many LICs at present, because their
financial integration is limited, and some monetary autonomy may remain.
However, it is important not to lost sight of the significant drawbacks of limited
international financial integration, including weakening of the disciplining
mechanism that financial integration may exert on a central bank and contribute
to its anti-inflation credibility. The strategy of an exchange rate peg is less likely
to be successful for relatively closed economies, where the exchange rate plays a
small role in domestic price formation. There is also a danger that the exchange
rate peg may be unsustainable—for example, if it is initially set at a level that, in
real terms, makes the economy uncompetitive, or if the convergence of domestic
inflation to inflation rates in the partner countries whose currencies provide the
currency peg does not occur rapidly.

Model description
This annex explains the details of the heterogeneous panel structural vector
autoregression (SVAR) methodology used in this chapter. The technique is an
adaptation of the heterogeneous panel SVAR methodology first developed by
Pedroni (2013). The method is modified to accommodate some of the specific
aspects of the analysis of this chapter.
The most important of these adaptations is to accommodate the details of the

reduced form specification used in the estimation and analysis of the inflation
dynamics in a way that takes advantage of the relatively abundant data sample.
To provide motivation for the adaptation, it is worth noting that the original
specification developed in Pedroni (2013) works under any method of
orthogonalization of the white noise impulses of a vector autoregression (VAR),
including the type of Cholesky orthogonalization used in this chapter. The
original specification imposes a form of structural discipline on the relationship
between the common and idiosyncratic components of these impulses that
allows the estimation and inference to be done with very short panels, even
though the dynamics are permitted to be heterogeneous among the countries of
the panel. Specifically, the approach envisions that the panel vector of what are
referred to as the structural impulses or “shocks” is decomposed into analogous
mutually orthogonal vectors of common and idiosyncratic structural shocks such
that the loadings on these vectors are diagonal.
To use a concrete example of this form of structure, taken from Pedroni (2013),
if such a panel vector is thought of as composed of two composite structural
AS AS
shocks, “aggregate supply,” ϵit , and “aggregate demand,” ϵitAD , so that ϵit = ( ϵit ,
AD
ϵit )' , then the relationship between these composite shocks and the
AD AS
corresponding common shocks ϵ̅ t = ( ϵ̅it , ϵ̅it )' and the corresponding
AS AD
idiosyncratic shocks ϵ̃ it = ( ϵ̃ it , ϵ̃ it )' , becomes ϵit = Λi ϵ̅ t + ϵ̃ it where Λi is the
diagonal loading matrix. To put it simply, aggregate demand shocks load only
into composite aggregate demand shocks, and not into composite aggregate
supply shocks, and so forth, so that the contributions of idiosyncratic and
common demand shocks sum to the contribution of the total composite
demand shocks. Once the vectors ϵit and ϵ̅ t have been structurally identified, the
diagonality of Λi on the factor structure for the white noise shocks permits
consistent estimation of the loadings by simple computation of the correlation
between the corresponding elements of ϵit and ϵ̅ t, which allows for good small
sample estimation properties even in relatively short panels.
By contrast, when the analysis is based on reduced form impulse shocks, as in

the case of this chapter, then it may be desirable to loosen this structural aspect,
since the white noise impulse shocks are themselves unknown linear
combinations of any underlying structural shocks. This in turn also allows the
shapes of the responses to the reduced form common and idiosyncratic
components to differ more substantially from one another, again presumably
because the mix of underlying structural shocks is free to differ among the
common and idiosyncratic components. The econometric cost to reducing these
structural aspects of the estimation is of course an increased need for data,
particularly in the time series dimension. But in the application in this chapter,
sufficient data were obtained to accomplish this.
Thus, to implement this adaptation, in the absence of diagonality of the loading

matrix, one of the simplest and most transparent approaches is to exploit
directly the remaining orthogonality between the common and idiosyncratic
shocks. This can be done by thinking of the panel SVAR as a common global
block and a country-specific domestic block nested within the panel, with the
orthogonality between the common and idiosyncratic shocks implemented
through a set of Granger noncausal restrictions. In effect, the panel SVAR is
estimated recursively in multiple tiers, in this case a global tier and a domestic
tier, with the global tier estimated first, and then placed within the domestic tier
in a manner such that the domestic tier has no impact on the global tier. The
global variables can be represented by cross-sectional averages of the national-
level variables, as in Pedroni (2013), by variables reported directly at the global
level, or any combination of the two.
To see the details of this adapted approach as it relates to the specific setup, let
∆Zit = ∆(Energyt , Foodt , Coret , foodit , coreit , neerit )' be the data vector, where
∆Energyt is global energy inflation, ∆Foodt is global food inflation, ∆Coret is
global average core inflation, ∆foodit is domestic food inflation instrumented by
the rainfall data, ∆coreit is domestic core inflation, and ∆neerit is the nominal
effective exchange rate (NEER) appreciation rate. In this case, the vector moving
average form for the panel can be represented here as ∆ Zit = A i (L)ϵ it , A i (L) =
Q
Σj = 0 A i j , with the upper left 3 x 3 block representing the global time-series
block, the lower right 3 x 3 block representing the local domestic block, and the
lower left 3 x 3 block representing the interactions running from the global block
to the domestic block. In precise terms, the Cholesky orthogonalization of the
error terms combined with the remaining orthogonalization into common
versus idiosyncratic shocks becomes equivalent to the following set of
restrictions in this notational form, namely [A( k, ℓ )j ]= 0 Ɐj ,Ɐk < ℓ when k ≤ 3,
A ( k, ℓ )j = 0 for j = 0, Ɐk < ℓ when k > 3.
However, these restrictions can be implemented equivalently by implementing a

recursive two-tiered estimation algorithm. The estimation algorithm for this
adaptation, which implements these restrictions, can now be summarized as
follows.
1. Construct the global variable block, by estimating cross-sectional averages

N
∆Zt = Nt-1 Σi=1t ∆Zit , where the notation Nt reflects that the panel need not
be balanced, or use global variables directly, as desired.
P
2. Estimate the 3 x 3 global tier VAR R (L)∆ Zt = µ̅ t , R (L) = I - Σ j =1 R j , E
[µ̅ t µ̅ t' ]= Ωμ and fix this block.
Pi
3. Estimate 6 x 6 individual VARs as Ri (L)∆Zit = μ it , Ri (L)= I - Σj=1 Ri,j,
E[μ it μ it' ] = Ωi,μ Ɐi with the global tier estimates imposed on the upper left
3 x 3 block and the lower right 3 x 3 block set to zero for all lags.
4. Use the Cholesky factorization Ωi,μ = Ai(0)Ai(0)' to orthogonalize the
reduced form shocks such that ϵit = Ai(0)-1μit , and compute the
corresponding country-specific impulse responses and variance
decompositions on the basis of Ai (L) = Ri(L)-1Ai(0).1
5. Use the sample distributions for individual country specific impulse
responses and variance decompositions to compute the quantile responses
among countries, if desired.2
6. Project the sample distributions for the individual impulse responses
and variance decompositions onto the sample distributions of individual
country characteristics i to study the country-specific characteristics
associated with the cross-sectional heterogeneity of the dynamics, such as
A i,s (k, ℓ) = αs + βs' i + i,s Ɐk, ℓ , s , s = 0, …,Q forecast horizons.
Data and sources

A monthly panel data set was used, covering 104 countries, including 25
advanced economies, 61 non-low-income-country (LIC) emerging market and
developing economies (EMDEs), and 18 LICs for 1970M2-2016M12.3 The
1 In this chapter, estimation of the VAR model is done on the basis of reduced-form VAR
representation and identification of the structural form, and representation of the results is based on the
structural vector moving average form.
2 Using a bootstrap method, this chapter checked the statistical significance of the impulse response
functions estimated from the heterogeneous panel SVAR model. The confidence intervals indicate that
the results are significant at the 5 percent level across all country groups.
3 The 104 countries included in the data set satisfy the panel SVAR condition that for a country to be
included in the sample, it must contain at least 36 months of continuous data for the intersection of the
country block, for all variables, namely (i) headline CPI, (ii) food CPI, (iii) energy CPI, (iv) core CPI, (v)
NEER, and (vi) rainfall.
panel data set is unbalanced, with the number of observations varying across
countries. Various sources were used to construct the monthly series on
headline, food, and energy inflation. The main sources for headline consumer
price index (CPI) inflation include Haver Analytics, the International Monetary
Fund (IMF) International Financial Statistics, and OECDstat. Similarly, food
and energy inflation data are covered by OECDstat, the Economic and
Statistical Observatory for Sub-Saharan Africa, and Haver Analytics. And, for
some countries, data were obtained from national sources. The NEER data were
obtained from the International Financial Statistics.
Core inflation. This is obtained by subtracting the contributions of volatile
components of the CPI, such as food and energy inflation. First, a measure of
core inflation is obtained by using official core data from OECDstat and Haver
Analytics. For the countries for which official core inflation was not available, it
was estimated by deducting food and energy 4 inflation multiplied by their
corresponding weights from headline CPI inflation and dividing this
contribution from the core by the weight of core inflation in the total CPI. The
following formula for calculating core inflation was utilized:
[π - ωF πF - ωE πE ]
Core inflation =
1- ωF - ωE
where π, πF , and πE are the current monthly inflation rates for headline, food,
and energy, respectively, and ωF and ωE are the current weights for food and
energy, respectively. Weights of the sub-indexes in the total index were obtained
from the Consumer Price Index database published by the IMF as well from
OECDstat and Haver Analytics.
Rainfall. Rainfall is used as an instrumental variable in identifying supply-driven

changes in domestic food prices. Rainfall monthly data come from the World
Bank’s Climate Change Knowledge Portal: Historical Data. The data set is
produced by the Climatic Research Unit of the University of East Anglia, and
reformatted by the International Water Management Institute. The monthly
mean historical rainfall data can be mapped to show the baseline climate and
seasonality by month. Rainfall is measured as millimeters per month for all
countries for 1970-2016. To test the relevancy of the instruments, panel-based
Lambda-Pearson statistics (or Fischer statistics) are used.5 Specifically, the
4 For most LICs and other EMDEs measures of monthly energy inflation are not available. Instead, for
these countries the calculation of core inflation uses the Housing, Water, Electricity, Gas and Other Fuels
category of the CPI as a proxy for energy inflation.
5 Constructing the F-statistic for joint significance of all the corresponding members of the panel
would not be desirable, because F-statistics are well known to behave poorly as the number of implied
restrictions grows large.
Lambda-Pearson statistic is constructed as -2.0xΣi lnPi (where, lnPi is the natural

log of the significance level associated with the F-test for significance of the
rainfall instrumental variable for country i). Under the null hypothesis of
significance of the rainfall instrumental variable for the panel, the Lambda-
Pearson panel statistic will have a chi-square distribution with 2xN degrees of
freedom, where N is the number of countries. The results show that the
instrumental variables are significant at the 5 percent level. (In the case of LICs,
they are significant at the 1 percent level.)
Country characteristics
To help explain the variation of domestic inflation, several potentially important
country-specific characteristics were used that may affect a nation’s inflation
rate. The characteristics considered are (i) the exchange rate regime by the
classification of Shambaugh (2004) (where “1” is assigned to countries that have
pegged or fixed exchange rates, and “0” is assigned to those with flexible
exchange rates); (ii) an indicator of whether a country has an inflation targeting
framework; (iii) Dincer and Eichengreen’s (2014) central bank transparency
index (the higher the index is, the more transparent and independent the central
bank is); (iv) gross public debt as a percentage of gross domestic product (GDP);
(v) trade openness, defined as the sum of exports and imports of goods and
services as a share of GDP from the World Bank’s World Development
Indicators and the IMF’s World Economic Outlook; (vi) an indicator of the
degree of global value chain (GVC) participation (where “1” is assigned to
countries that are considered to be well-integrated into GVCs and “0”
otherwise); (vii) the Chinn and Ito (2018) index of capital account openness;
(viii) an indicator of whether a country is a commodity importer or exporter;
and (ix) central bank turnover, using data compiled by Dreher, Sturm, and de
Haan (2010). For a complete list of the country characteristics, sources, and
methods used for construction of the indicators, see the Appendix.
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Monetary and Exchange Rate Policies in Emerging Economies.” IMF Staff Discussion Note
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Egypt.” ECES (The Egypt Center for Economic Studies) Distinguished Lecture 23, Cairo,
Egypt.
CHAPTER 7
Poverty Impacts of Food Price Shocks and Policies
In the event of large swings in world food prices, countries often intervene to dampen
the impact of international food price spikes on domestic prices and lessen the burden
of adjustment on vulnerable population groups. Although individual countries can
succeed in insulating their domestic markets from short-term fluctuations in global
food prices, the collective intervention of many countries exacerbates the volatility of
world prices. Insulating policies introduced during the 2010-11 food price spike
accounted for 40 percent of the increase in the world price of wheat and 25 percent
of the increase in the world price of maize. Combined with government policy
responses, the 2010-11 food price spike increased global poverty by 1 percent or 8.3
million people.
Introduction
In August 2011, international food prices hit an all-time high.1 This followed
shortly after the 2007-08 food price spike, which pushed an estimated 105
million people into extreme poverty (Ivanic and Martin 2008). This event also
prompted widespread concerns about the food security of the poorest. Although
food prices have declined considerably since then, in real terms, they are still
significantly above their 2000 lows (Figure 7.1). New evidence points to a rise in
world hunger and severe food insecurity between 2014 and 2017, reversing the
declining trend observed in the previous decade. In 2017, the number of
undernourished people reached 821 million, up by 5 percent since 2014 and a
major step backward in achieving the second Sustainable Development Goal
(SDG 2) target of hunger eradication by 2030 (FAO et al. 2018). Climate
variability and the growing frequency of extreme weather events increase the risk
of disruption to food production and are accompanied by food price spikes and
setbacks in food availability and access to food.
Food prices are determined by the complex interaction between demand and
supply forces. A dramatic increase in demand for feedstock for biofuel
production in the early 2000s put considerable pressure on markets for grain
and contributed to a rundown in stocks (Akiyama et al. 2001; Wright 2014).
Note: This chapter was prepared by David Laborde, Csilla Lakatos, and Will Martin. David Laborde
and Will Martin acknowledge the funding support of the CGIAR Research Program on Policies,
Institutions, and Markets (PIM) led by the International Food Policy Research Institute (IFPRI). The
opinions expressed here belong to the authors and do not necessarily reflect those of PIM, IFPRI, or
CGIAR.
1 Unless otherwise stated, the concept of food prices as used in this chapter refers to the commodity
prices of major staple foods such as rice, wheat, and maize.

Population growth and urbanization, as well as a shift in diets toward animal-

based foods, created demand pressures despite an increase in agricultural
productivity in emerging market and developing economies (EMDEs) (Fukase
and Martin 2017). Slowing yield growth and declining availability of
agricultural land also constrained food production growth. Extreme climate
events (for example, El Niño, droughts, and natural disasters), particularly when
stock levels have been low, have also contributed to food price volatility.
Food price increases have important macroeconomic and microeconomic

impacts through several channels. At the macroeconomic level, food price
increases result in higher inflation, which can significantly affect household real
incomes. High food prices can also result in terms-of-trade shocks, with
important implications for growth and government policy space.
The microeconomic impact of food price increases on poverty and inequality

depends on the net food seller status of the poorest households. For households
that are net sellers of food products (such as farmers, agricultural workers, and
small landowners), rising food prices increase real incomes. By contrast, they
lower the real incomes of households who are net buyers of food. In low-income
countries (LICs), poor urban households spend large shares of their income on
food and are likely to feel the effects of such declines in real incomes most
severely. On average, sharp increases in food prices raise poverty, reduce
nutrition, and curtail the consumption of essential services such as education
and health care (World Bank 2011). In the longer term, once producers and
consumers have adjusted to the increases and wage rates have responded,
sustained increases in food prices may lower poverty (Ivanic and Martin 2014b;
Gillson and Fouad 2014).
A decline in food prices can also have adverse impacts on net sellers of food,
particularly in the short term, when they are highly dependent on revenues from
crops. Interest groups often put pressure on governments not to allow food
prices to fall too rapidly.
Countries often use policy interventions to dampen the domestic impact of

international food price spikes and lessen the burden on vulnerable population
groups. For example, during the 2007-08 food price spike, close to three-
quarters of EMDEs took policy action to insulate their domestic prices from the
sharp increase in international food prices (World Bank 2009). In the event of
food price spikes, net importers usually intervene by lowering rates of protection
(typically tariffs) on food, and net exporters impose export restrictions or bans.
These policies are often complemented with social safety net programs, such as
cash transfers or school feeding programs, that help deal with the income effects
of the food price rise without distorting domestic prices.
FIGURE 7.1 Global food prices

In August 2011, shortly after the 2007-08 food price spike, international nominal food prices
hit an all-time high. Although food prices have declined considerably since then, in real
terms, they are still significantly above their lows in the 2000s.
A. Global food prices B. Global food price volatility
Source: World Bank.

A. Based on yearly commodity price indexes between 1960 and 2017. The World Bank manufactures unit value index is
used as a deflator.
B. Based on monthly nominal commodity price indexes between January 1960 and November 2017.
To the extent that policy interventions reduce the transmission of international

price spikes to domestic markets, they may appear to be successful for individual
countries. However, the combined intervention of many countries raises
international prices. These insulating policies tend to encourage consumption
and reduce production during price spikes. This, in turn, results in higher
import demand and reduced export supply that further drive up global prices.
During price plunges, government interventions encourage greater exports and
greater global supply, which further depresses prices. Only countries that
insulate themselves to an above average degree can reduce price volatility in their
domestic markets (Anderson, Martin, and Ivanic 2017).
The international community has recognized the importance of ensuring the

stability and availability of food supplies as key to addressing several
development objectives. The Sustainable Development Goals (SDGs) give food
security a high priority: SDG 2 sets out explicitly the goal to “end hunger,
achieve food security and improved nutrition, and promote sustainable
agriculture.” Other SDGs are strongly interconnected: food, agriculture, and
nutrition play an important role in SDG 1 on ending poverty, SDG 12 on
sustainable consumption and production, and SDG 13 on climate change
adaptation and mitigation.
In this context, this chapter addresses the following questions:
• How do food price shocks affect EMDEs and LICs?

• How do countries intervene to reduce the impact of food price shocks?

• What was the impact of the 2010-11 food price shock on poverty?
The chapter presents the following findings:
• At the macroeconomic level, a high share of agriculture and food in total
output, consumption, employment, trade, and government revenues
heightens countries’ vulnerability to volatility in international food prices.
At the microeconomic level, food price spikes are felt most severely by the
poorest segments of the population who are net food buyers.
• Governments in EMDEs tend to respond particularly strongly to sharp
changes in world prices for staple foods—such as rice, wheat, and maize—
to smooth volatility. Domestic food prices are considerably less volatile than
world food prices in the short run, but over the longer term, there is a
tendency for domestic and world prices to return to their original
relationship. In the short run, a 1 percent increase in world rice, wheat, and
maize prices is associated with an increase in domestic prices by 0.6, 0.7,
and 0.8 percent, respectively.
• Although individual countries can succeed at insulating their domestic
markets from short-term fluctuations in global food prices, their combined
interventions make global food prices more volatile. Insulating policies
introduced during the 2010-11 food price spike accounted for 40 percent of
the increase in the world price of wheat and 25 percent of the increase in
the world price of maize. In contrast, government interventions in rice
markets dampened the degree to which world prices increased by about 50
percent.
• The 2010-11 food price spike increased poverty by 1 percent, or 8.3 million
people, despite widespread government intervention.
The chapter contributes to two strands of the literature: the implications of
government interventions to insulate domestic grain markets, and the impacts of
changes in world food prices on poverty. First, the chapter discusses the features
and sources of the 2010-11 food price spike. Second, it quantifies the degree to
which countries intervened. Third, the chapter is the first study to quantify the
poverty impact of the 2010-11 food price spike and associated trade policy
interventions.
Food price shocks

At the macroeconomic level, high shares of agriculture and food in total output,
consumption, employment, trade, and government revenues heighten countries’
vulnerability to volatility in international food prices. At the microeconomic

level, a high share of net food buyers among the poorest segments of society
heightens the adverse effects of food price spikes on poverty and income
distribution.
Macroeconomic channels
Reliance on food imports and production. Agriculture accounts for close to

one-third of total value added and two-thirds of total employment in LICs. This
is almost three times their shares in the average EMDE (Figure 7.2) (Aksoy and
Beghin 2004). For example, in Burkina Faso and Burundi, agriculture accounts
for more than four-fifths of total employment. In Chad and Sierra Leone, it
accounts for more than half of domestic value added. In addition, more than
three-quarters of LICs are net food importers compared to only half of EMDEs.
In these net food-importing LICs, net food imports amount to 5.4 percent of
private consumption. Benin and the Gambia are particularly vulnerable to high
food prices, with net food imports at more than 10 percent of private
consumption.2
Inflation. A surge in food prices increases consumer price index (CPI) inflation.
For example, the 2007-08 and 2010-11 surges in international food prices
caused substantial inflationary pressures. LIC inflation more than doubled, from
7 to 15 percent during 2007-08 and from 5 to 11 percent during 2010-11. The
increase in EMDE inflation was less pronounced, from 7 to 11 percent during
2007-08 and from 5 to 6 percent during 2010-11. Food prices accounted
disproportionately for these increases in inflation—for about two-thirds in LICs
and more than half in EMDEs. In vulnerable LICs, such as Benin and Niger,
where net food imports amount to 15 and 7 percent of household consumption,
respectively, inflation surged from 1 to 8 percent and from 0.2 to 11 percent,
respectively, during the 2007-08 food price spike.
Terms of trade. Sharp increases in food prices can result in significant adverse
terms-of-trade shocks, especially for countries that are large net importers of
food. More than three-quarters of LICs are net food importers. Accordingly,
in the median LIC, the terms-of-trade index declined by 2 and 4 percent during
the 2007-08 and 2010-11 food price spikes, respectively. In some,
the deterioration was much steeper. For example, the terms of trade index of
Sierra Leone, an LIC highly reliant on food imports, weakened by 10 percent
during each of these food price spike episodes. More broadly, severe terms-of-
trade shocks are considerably more common in LICs than in advanced
2 Conversely, heavy reliance on food exports heightens vulnerability to food price declines. For
example, in Malawi, net food exports amount to 12 percent of total private consumption.
FIGURE 7.2 Macroeconomic channels of transmission

At the macroeconomic level, high shares of agriculture and food in total output,
consumption, employment, trade, and government revenues heighten countries’
vulnerability to volatility in international food prices.
A. Share of agriculture in economy B. Net food importers and exporters
C. Inflation in LICs D. Contribution of food prices to inflation
E. Terms of trade in LICs F. Fiscal balance in LICs
Source: World Bank; Kose et al. 2017.

Note: EMDEs = emerging market and developing economies; GDP = gross domestic product; LICs = low-income
countries.
A. Based on a sample of 93 EMDEs and 21 LICs. Averages for 2010-16.
B. Blue bars show the share of EMDEs or LICs in which food imports exceed food exports (“net food importers”) or food
imports fall short of food exports (“net food exporters”). Red bars show net food imports relative to consumption in EMDE
and LIC food exporters and importers.
C. Average inflation based on a sample of 12 LICs.
D. Share of inflation accounted for by food price inflation. The orange line indicates half.
E. Net barter terms of trade index, 2000 = 100.
F. Median based on a sample of 26 LICs.
economies (IMF 2011). In addition, of all possible external shocks, negative

terms-of-trade shocks tend to have the most severe output cost in LICs (Becker
and Mauro 2006).
Fiscal policy constraints. Heavy reliance on food and agricultural exports

exposes many countries to the volatility of international commodity prices.
Absent stabilizing fiscal arrangements, this can introduce volatility into public
finances and erode fiscal sustainability: rising food prices may increase tax
revenues from the agriculture sector and encourage governments to spend.
Conversely, when food prices fall, revenue losses in the agriculture sector are
exacerbated by political pressures to subsidize food production. Food price
spikes may also cause sociopolitical instability, including political unrest and
food riots (Barrett 2013). During the sharp rise in food prices in 2007-08, LICs’
fiscal balances deteriorated, on average, by close to 1 percentage point of gross
domestic product (GDP), partly due to higher food import bills.
Monetary policy constraints. In countries where inflation expectations are not

well anchored and monetary policy frameworks are weak, the increase in
inflation caused by rising food prices can compel central banks to tighten policy.
In heavy food importers, this can be exacerbated by exchange rate depreciation
in response to the deteriorating terms of trade. Indeed, during the 2007-08 food
price spike, close to half of EMDE central banks responded to rising inflation
and depreciation by tightening monetary policy.3
Microeconomic channels
Rising food prices impact households through price and income effects. Rising
food prices reduce households’ purchasing power but raise income generated
from food production.
Poor households—those with per capita income less than $2.97/day—spend on

average more than half of their income on food in EMDEs and close to two-
thirds in LICs (Figure 7.3). In countries such as Burundi, Guinea, and
Honduras, the share of food expenditures is even higher, accounting for more
than three-quarters of total consumption of the poorest households. In LICs,
more than one-third of the poorest households’ consumption expenditure on
food is spent on staple foods such as cereals and vegetables. These staple foods
are considerably more exposed to international price volatility than are
domestically processed food products (Figure 7.1).
3 Based on a sample of 54 EMDEs.

FIGURE 7.3 Microeconomic channels of transmission

At the microeconomic level, a high share of net food buyers among the poorest segments
of the population heightens the adverse effects of food price spikes on income distribution
and poverty.
A. Share of food in total consumption B. Consumption expenditure of the poorest

expenditure households, by product
C. Share of net food sellers D. Share of income generated by food in the

income of the poor
Source: World Bank; International Food Policy Research Institute.

Note: EMDEs = emerging market and developing economies; LICs = low-income countries.
A. Based on 2010 data on the share of food in the total consumption expenditure of households.
B. Based on 2010 data on the share of products in total household consumption expenditure.
C.D. Averages weighted by the number of poor for a sample of 22 EMDEs and 7 LICs. Based on a poverty line
of $1.90/ day.
For households that are net sellers of agricultural and food products (for
example, farmers), rising food prices raise incomes. More than one-fifth of
households around and below the poverty line are net food sellers in the average
EMDE and LIC. Households around and below the poverty line in these
countries tend to generate about one-quarter of their incomes from food
production.
The overall impact depends on the relative magnitudes of income and price
effects of households in different segments of the income distribution. If the
positive income effect outweighs the overall loss of purchasing power, household
real incomes rise. In contrast, poor urban households, which are typically net
buyers of food that spend a large share of their consumption expenditure on
food, are likely to suffer real income losses (Aksoy and Hoekman 2010).
On average, many of the poor in EMDEs and LICs are net buyers of food. As a
result, food price spikes tend to raise poverty, reduce nutrition, and cut
consumption of essential services such as education and health care. For
example, the 2007-08 rise in food prices is estimated to have raised the number
of poor by 105 million (Ivanic and Martin 2008). In extreme cases, food price
spikes can induce food insecurity and hunger, with severely adverse long-term
impacts on human capital.
Government interventions
In the event of large swings in global food prices, governments are confronted
with difficult policy choices. One option is to allow domestic prices to adjust to
world food price changes, exposing domestic consumers and producers to
changes in their real incomes.4 However, this may raise inflation in the short run
and, in countries where inflation expectations are poorly anchored, in the
medium to long run.5 The decline in real incomes of poor net buyers associated
with higher inflation (Easterly and Fischer 2001) would entail welfare losses,
especially when net consumers of food are loss- and risk-averse (Gouel and Jean
2015; Freund and Ozden 2008; Giordani, Rocha, and Ruta 2016). Meanwhile,
net sellers of food may gain.
Alternatively, governments can spare consumers or producers these losses by

reducing the transmission of international food price shocks to domestic
markets.6 As measured in this chapter, policy intervention is reflected in the
ratio of domestic to world prices—the “protection rate.” If, during a period of
rising world prices, the rate of protection declines, a country is seeking to
insulate its domestic markets from the increase in prices. If the protection rate
rises, policy makers are compounding the increase in world prices. This may
occur with the objective of correcting past “errors,” because domestic prices fell
below policy makers’ desired long-run level, or because policy has insulated the
4 A sizable nontradable services component in the cost of providing consumers with food
(transportation, storage, retail, and so forth) dampens the pass-through of changes in world food prices
into domestic markets.
5 In principle, monetary policy tightening can also offset inflationary effects from rising global food
prices to ensure that rising food prices remain a purely relative price change and do not become
entrenched in higher inflation. However, this would come at the cost of reduced economic activity
(Lustig 2009). Among LICs, only Uganda is formally committed to an inflation targeting regime, which
aims to keep average annual core inflation at 5 percent ± 2 percent.
6 Policy makers may also have a longer-term goal to protect (or tax) domestic agents (Grossman and
Helpman 1994). In empirical work based on political economy models, protection rates vary to reduce
the costs associated with adjusting prices and the costs of providing a rate of protection that differs from
the long-run political equilibrium (Anderson and Nelgen 2011; Ivanic and Martin 2014a).
market from world markets and an exogenous shock, such as a harvest shortfall,
has caused the domestic price to rise relative to the world price.7
In practice, during the 2007-08 food price spike, close to three-quarters of

EMDEs took policy action to insulate their economies from the sharp increase
in international food prices (World Bank 2009). The most commonly used
interventions were reductions in taxes, including import duties and consumer
taxes (Figure 7.4). Net importers frequently intervened by lowering import
tariffs or even introducing import subsidies, and net exporters imposed export
restrictions or bans to dampen the increase in domestic prices.
Domestic and world food price dynamics
Domestic food prices are considerably less volatile than global food prices in the
short run, but over the longer term, there is a tendency for domestic prices to
return to their original relationship with international prices (Figure 7.5). This
does not necessarily imply that protection rates become zero, but that they
return to their pre-spike levels.
Governments in EMDEs tend to respond particularly strongly to sharp changes

in the world prices of staple foods—such as rice, wheat, and maize—to reduce
the volatility of domestic prices. For staple foods, domestic price movements can
diverge substantially from international price movements in the short run but
converge in the longer term.
The movements of world and domestic food staple prices during the latest two
food price spikes (2007-08 and 2010-11) resembled similar earlier episodes:
world prices rose rapidly, and domestic prices rose only gradually. However, the
2010-11 spike was different from previous episodes in several respects. The
2007-08 increase in food prices came after a long period of stability in food
prices. In 2007-08, world prices of all staple foods increased steeply, led by the
strong increase in the world price of rice. Most countries reacted strongly by
introducing insulating policies. In contrast, the 2010-11 episode occurred when
world markets and policies were still normalizing from the 2007-08 episode.
Government interventions therefore differed considerably across countries and
commodities. Government interventions raised rice prices more than the
modest increase in world prices.
Rice. Rice was the staple food with the largest price increase during the 2007-08
food price spike. Between January 2007 and May 2008, world rice prices almost
7 A similar pattern was observed in the maize market in many African countries (Chapoto and
Jayne 2009).
FIGURE 7.4 Food-related government policies

Countries often use policy interventions to dampen the domestic impact of international
food price spikes and lessen the burden on vulnerable population groups. In the short run,
domestic markets for key staple foods, such as rice, maize, and wheat, are highly insulated
from global food price swings. Insulation policies undertaken during the 2010-11 episode
exacerbated the volatility of world prices and accounted for about 40 percent of the
increase in the world price of wheat and one-quarter of the increase in the world price of
maize.
A. Interventions in agricultural markets B. Policy interventions during the 2008 food

price spike
C. Insulation and correction coefficients D. Increase in world prices, 2010-11
Source: Ivanic and Martin (2014a), Ag-Incentives Database, World Bank.

A. Nominal Rate of Protection (NRP) is computed as the price difference between the farm gate price received by
producers and an undistorted reference price at the farm gate level. The reference price at the farm gate level is defined as
the net price of the product when it leaves the farm, after marketing costs have been subtracted. The undistorted farm gate
price is defined as the price prevailing in competitive world markets.
B. Percent of respondents based on a survey of 80 EMDEs.
C. Estimates based on the error correction model described in Annex 7.1. The coefficient of price insulation ranges from
0 for countries that do not insulate against the rise in world prices, to -1 for countries that adopt policies that fully insulate
domestic markets. The error correction term represents the cost of being out of equilibrium or the speed with which policies
achieve the target level of protection or at which policy makers move back toward this equilibrium after being forced away
from it by a shock to world prices. Based on data for 82 countries, of which 26 advanced economies, 44 EMDEs, and 12
LICs for the period 1955-2011.
D. Estimates derived based on the methodology described in Annex 7.1.
tripled.8 This sharp increase reflected export restrictions introduced by major

suppliers (for example, India and Vietnam), triggered by food security concerns,
panic buying by several large importers, a weak dollar, and record high prices of
8 The world price of 5 percent broken white Thai rice increased from $313/metric ton (mt) to
$902/mt.
FIGURE 7.5 Domestic and global food prices

Domestic food prices tend to be less volatile than global food prices. This partly reflects a
sizable services component in the cost of providing domestic consumers with food, but
also policy intervention.
A. Prices of staple foods B. Rice prices
C. Wheat prices D. Maize prices
E. Domestic and global staple food prices, F. Average increase in the world and
2007-08 and 2010-11 domestic price indexes, 2010-11
Source: Ivanic and Martin 2014a; World Bank.

Note: Trade-weighted averages.
A. Rice, wheat, maize, edible oil, and sugar prices.
E. Event study based on monthly cross-country average domestic staples prices (average of wheat, rice, and maize prices)
and global staples prices (average of wheat, rice, and maize) during 2007-08 and 2010-11. Period 0 represents the month
of the peak of the world food price spike.
F. Average percent increase in the price index.
oil, which is a major input into food production (Childs and Kiawu 2009).
During this episode, domestic markets were largely insulated from this global
rice price spike (Ivanic and Martin 2008). By contrast, during the 2010-11 price
spike, rice prices increased much less, by about 30 percent between June 2010
and May 2012. In some countries, adverse supply conditions combined with the
use of nontariff trade policies resulted in domestic rice prices rising above world
prices.9 Instead of insulating policies, on average, EMDEs implemented policies
that raised domestic prices relative to world prices (Figure 7.5).
Wheat. Between February 2007 and March 2008, world wheat prices more than
doubled, partly in response to lower than anticipated wheat production caused
by drought in Australia, Ukraine, and other major exporters.10 Strong policy
intervention partially insulated domestic markets from the global wheat price
spike and its subsequent collapse in the aftermath of the global financial crisis in
2009-10. Similarly, during the 2010-11 event, world wheat prices more than
doubled between June 2010 and May 2011.11 This time, the increase in world
prices was partly driven by lower than expected production and exports in
Kazakhstan, the Russian Federation, and Ukraine and excessive rains in Australia
that damaged wheat crops (World Bank 2010). Large orders from major wheat
importers in the Middle East and North Africa added to price pressures. Since
2011, global and domestic wheat prices have fluctuated, broadly synchronously.
Maize. During the 2007-08 food price spike, the world price of maize almost
doubled, partly as a result of increasing U.S. demand for maize stimulated by
mandatory targets for ethanol production.12 Similarly, during the 2010-11
episode, the world price of maize increased significantly. As in the case of wheat,
adverse weather-related events in major maize-exporting countries contributed
to the spike in world prices. In contrast, many countries in Sub-Saharan Africa
benefited from excellent maize harvests, which, in combination with
unpredictable trade policies, led to sharp falls in domestic prices.
Insulation of domestic food markets
The degree of insulation of domestic markets from world food price swings can
be quantified using an error correction model (ECM) (Annex 7.1). In this
analytical framework, domestic food prices are represented as the outcome of a
policy process in which policy makers seek to reduce the cost of adjustment as
well as the cost of being out of equilibrium (Nickell 1985).
The ECM regresses the log of the protection rate on the log of world prices and
the deviation from long-term “equilibrium” food prices. The sample used here
includes annual data for eight food commodity prices in 82 countries, of which
44 are EMDEs and 12 are LICs, during 1955-2011.
9 In Vietnam, for instance, domestic rice prices rose by 41 percent between July and October 2010 due
to lower than expected production, prior commitments on exports, and high inflation from a depreciating
currency.
10 The world price of U.S. hard red wheat increased from $196/mt to $440/mt.
11 The world price of U.S. hard red wheat increased from $158/mt to $355/mt.
12 Between January 2007 and June 2008, the world price of maize increased from $165/mt to $287/mt.
The degree of insulation of an increase in global food prices is captured by the

coefficient estimate of short-term changes in global food prices. A more negative
coefficient indicates a higher degree of insulation in the short term. The degree
of long-term adjustment to a 1 percent increase in global food prices is captured
by the coefficient on the error correction term. A coefficient near -1 indicates
that, over the long term, cumulative global and domestic price swings converge.
Estimates from the ECM point to short-term insulation in markets for key
staple foods such as rice and wheat (Figure 7.4). Among these key staples,
insulation is the highest for rice. In the short run, a 1 percent increase in global
rice, wheat, and maize prices is associated with an increase in domestic prices of
0.6, 0.7, and 0.8 percent, respectively.
Certain types of interventions in markets for staple foods have been found to
raise volatility in domestic markets. For example, during the 2008-09 food price
spike, several African countries implemented pricing, marketing, and trade
policy interventions to stabilize domestic maize markets. The countries that
intervened most intensively experienced the highest domestic price volatility,
mostly because of the ad hoc and unpredictable nature of these interventions
(Chapoto and Jayne 2009).13
The use of an export ban during food price spikes, possibly related to a domestic
drought, illustrates the trade-offs between different policy instruments:
• Ensuring food security. By restricting the sale of food for exports, an export
ban increases domestic supply and dampens domestic food price increases.
This can help net food buyers access food.
• Alleviating poverty. Net food-selling farmers are likely to be hardest hit by a

drought. An export ban reduces their ability to mitigate their production
losses with higher incomes from higher prices. If these farmers are among
the poorer segments of the income distribution, the export ban will likely
increase poverty, as observed in Zambia during the 2016-17 El Niño event
(Al-Mamun et al. 2017).
• Volatility. Although export bans may alleviate pressures during a specific

situation, they heighten domestic price volatility by preventing domestic
shocks from being dissipated through changes in trade levels. If bans are
13 After abstaining from the use of interventions in staple food markets for several years, policy makers
in Eastern and Southern Africa extensively used pricing, marketing, and trade policy tools during the
2015-16 agricultural season to contain the impact of an El Niño-induced decline in output and food
security (Al-Mamun et al. 2017; Tschirley and Jayne 2010).
backed up by stockholding measures, such as those used in India (Gouel,

Gautam, and Martin 2016), they can be consistent with domestic price
stabilization.
Although individual countries can succeed at insulating their domestic markets

from short-term fluctuations in global food prices, their combined policies make
global food prices more volatile. Government interventions tend to increase
consumption and reduce production during price spikes and support production
and discourage consumption during price plunges. During price spikes, this
results in higher import demand and, hence, higher global demand that further
drives up global prices. During price plunges, it encourages greater exports from
each country and, hence, greater global supply that further depresses prices.
Only countries that insulate themselves to an above average degree can reduce
the transmission of international price volatility to their domestic markets
(Anderson, Martin, and Ivanic 2017; Martin and Anderson 2012; Ivanic and
Martin 2014a).14
Impact of the 2010-11 food price shock on poverty

The impact of the 2010-11 food price shock on poverty is quantified in two
steps. In the first step, the degree of intervention by countries is estimated based
on a framework developed by Anderson, Ivanic, and Martin (2014). In the
second step, these estimates are fed into a computable general equilibrium
(CGE) model to determine the impact of insulation policies on poverty. Two
scenarios are modeled. In the first scenario, the impact of countries’ own
interventions on poverty is considered. In the second scenario, the combined
effect of all policy interventions on global food markets and their feedback to
domestic poverty are quantified.
Quantifying trade policy interventions
The approach to quantifying the extent of trade policy interventions builds on

that used in Anderson, Ivanic, and Martin (2014). A primary shock, such as a
weather shock, is assumed to generate an initial change in domestic and world
prices. In attempting to insulate domestic markets from the increase in world
prices, governments make offsetting changes to protection measures, such as the
introduction of export bans (food exporters) or the reduction of import duties
(food importers). These measures, in turn, reinforce the original shock to world
prices. When a country imposes an export restriction, the availability of food to
14 Consistent with Martin and Anderson (2012) and Anderson, Ivanic, and Martin (2014).
the rest of the world is reduced, and this tends to push up world prices.
Similarly, when an importing country reduces its import tariffs, it increases the
demand for imports and hence puts upward pressure on world prices
(Annex 7.1).
Similarly, when an importing country reduces its import tariffs, it increases the
demand for imports and, as a consequence, puts upward pressure on world
prices (Annex 7.1).
The data used for quantifying the extent of trade policy interventions are taken
primarily from the Ag-Incentives Consortium database.15 The database provides
estimates of changes in domestic and world prices for 57 countries and 68
agricultural and food commodities during 2005-15. Where data from the
Ag-Incentives database were unavailable, alternative data were used from
FAOSTAT, Global Information and Early Warning System, and Fewsnet.
Overall, this analysis covers 24 major food producing and consuming countries,
using data on household income sources and spending patterns from 2011. Of
these, 18 are EMDEs and 6 are LICs.
During the food price spike of 2010-11, world prices of maize, wheat, and rice
rose by 44, 39, and 6 percent, respectively (Figure 7.4). In contrast, domestic
prices rose by considerably less, pointing to substantial insulation, with
considerable heterogeneity across countries and commodities.
• Rice. Some countries (for example, Bangladesh, Nepal, Panama, Tanzania,
and Zambia) reduced trade barriers to offset partially the rise in world rise
prices. However, important net rice exporters, such as India, Pakistan, and
the Republic of Yemen, implemented policy interventions that, ultimately,
raised domestic rice prices more than the increase in world prices. In India,
the world’s second largest rice producer, quantitative restrictions initially
prevented domestic price increases. However, the subsequent abolition of
export quotas in September 2011 (in place since 2007) coincided with the
agricultural marketing season and resulted in a surge in exports and a rise in
domestic prices. In Pakistan, domestic rice prices rose relative to the world
price over this same period because of heavy summer flooding that affected
one-fifth of the country’s land area and inflicted extensive damage to crops.
A large increase in domestic prices relative to external prices occurred in the
Republic of Yemen, amid persistent water shortages and a shift to less
water-intensive non-staple crops. Prices also rose modestly in Ethiopia and
Uganda because of drought. The combined intervention of all countries
dampened the increase in the world price of rice by about 50 percent
compared to a scenario without insulation policies.
15 The data are available at www.ag-incentives.org.

• Wheat. Most developing countries took measures to offset the increase in

global wheat prices in 2010-11. Policy actions and the degree of insulation
were broadly similar to those employed during the spike in wheat prices in
2007-08. Policy makers justified efforts to dampen the impact of the global
wheat price spike by noting that the world wheat price spike partly reflected
a catching up with rising domestic wheat prices.16 The combined
intervention of countries accounted for close to 50 percent of the increase
in the world price of wheat.
• Maize. Although most countries insulated their domestic maize markets

against maize price increases during 2010-11, there was considerable
heterogeneity in the policy responses. In Bangladesh, Ecuador, Malawi,
Tanzania, and Zambia, protection rates were reduced to offset fully the rise
in global maize prices. Ethiopia, Uganda, and the Republic of Yemen
increased protection rates or used policies that, in combination with
domestic output shocks, reinforced the effect of the increase in world prices
on domestic prices.
During the 2010-11 event, the combined action of government policies raised
global wheat and maize prices, accounting for about 40 percent of the increase
in the world price of wheat and 25 percent of the increase in the price of maize
(Figure 7.4). In the case of rice, combined policy actions reduced the rice price
surge compared to a scenario of nonaction.17
Poverty implications
To assess the poverty implications of the 2010-11 increase in the world prices of
rice, wheat, and maize, the MIRAGRODEP general equilibrium model was
used in combination with household models for 285,000 households from 31
countries (Laborde, Robichaud, and Tokgoz 2013). MIRAGRODEP is a
dynamic, multicountry, and multisector CGE model (Annex 7.1). The poverty
impact depends on price changes, the relative reliance of households on the
consumption of individual staple foods, and the net food buying status of
households in different segments of the distribution (Deaton 1989).
16 Ethiopia is an exception, where domestic wheat prices rose 28 percentage points more than world
prices during 2010-11. This reflected domestic supply shocks, combined with limited access to global
wheat markets to alleviate shortages. Wheat output fell by 10 percent in 2010-11 as a result of a fungus
that destroyed the wheat harvest and lowered stocks in 2011. Wheat imports rose but were constrained
by tight foreign exchange controls, effectively stopping private sector imports and ensuring that all grain
imports were channeled through the state-owned Ethiopian Grain Trade Enterprise (Wakeyo and Lanos
2014; Negassa and Jayne 1997).
17 This primarily reflects the elimination of export restrictions in India and increased import
protection in Pakistan, Indonesia, Uganda, and the Republic of Yemen.

The results show that a hypothetical 10 percent surge in rice, wheat, and maize
prices raises the number of poor by 0.22 percent, or 2.1 million people. Among
staple foods, an increase in wheat prices raises the number of poor most (0.01
percentage point for a 10 percent wheat price increase). Rice price increases
cause particularly large increases in the number of poor in Sub-Saharan Africa
(0.13 percentage point). Finally, maize price increases tend to have a lesser
impact on the number of poor.
To model the interaction between food price shocks and government

interventions, the effects of a supply shock are traced in the model. The model
assumes that an adverse productivity shock outside developing countries, in
particular, in the Black Sea Basin and Australia, triggers the increase in world
prices. In the summer of 2010, major grain producers in the Black Sea Basin,
such as Russia, Ukraine, and Kazakhstan, were hit by a severe drought that
significantly affected their harvest, and excessive rains in Australia caused by La
Niña damaged crops, which were downgraded to feed quality (World Bank
2010). Primary shocks in these regions are assumed not to contribute directly to
global changes in poverty rates, given their small share of the population living
below the poverty line of $1.90/day.
The productivity shocks are calibrated to match the observed changes in

protection rates and world prices given in Figure 7.6. For example, given the
initial protection rates, a negative production shock of 55 percent for rice, 27
percent for wheat, and 35 percent for maize in advanced economies and Russia
generates an increase of 10 percent in average world prices for these
commodities. The policy experiments are implemented by eliminating
individual trade policy measures for each country. In each case, world prices are
recomputed endogenously in the model and therefore capture the direct and
indirect effects of the policy changes.
As the model used in the simulations distinguishes between domestic and

imported goods, two potential policy instruments are considered—an import
duty (or subsidy) and an export subsidy (or tax).18 The use of such policies can
distort trade flows to such an extent that they switch between net-exporting and
net-importing status. As a result, many countries typically put in place flanking
policies. In 2007-08, for example, the Arab Republic of Egypt and Indonesia
18 Because rice, wheat, and maize are bulk commodities that are less strongly differentiated than
manufactured products, two-way trade in these goods is unusual—except when there are regional
differences in varieties. Regionally differentiated varieties could create two-way trade flows such as, for
example, Indian exports of basmati rice and imports of jasmine rice. Although the limited extent of two-
way trade in these products might suggest treating them as homogeneous products, models of
differentiated products are needed to capture adequately the bilateral trade flows in these commodities
(Thursby, Johnson, and Grennes 1986).
FIGURE 7.6 Government interventions during 2010-11

Some countries reduced trade barriers to insulate themselves from increasing world
prices. Others resorted to policy interventions that ultimately raised domestic prices more
than the increase in world prices.
A. Change in protection rates B. Change in protection rates
C. Change in EMDE protection rates D. Change in LIC protection rates
Source: Ag-Incentives Database.

Note: Estimates based on the methodology described in Annex 7.1. Changes in the rates of protection are presented in the
form Ti = ∆t/(1+t0), where t is the initial rate of protection (positive if an import tariff or export subsidy) and ∆t is the change
in this rate of protection. If the change in the rate of protection is negative during a period of rising world prices, countries
are seeking to insulate their markets from the increase in prices. If it is positive, policy makers are compounding the
increase in world prices with an increase in protection, which may be due to the correction of past “errors”: if domestic
prices fall below policy makers’ desired long-run level of protection, or if a policy that insulated the domestic market from
world markets and a subsequent exogenous shock—such as a harvest shortfall—has caused the domestic price to rise
relative to the world price. EMDEs = emerging market and developing economies; LICs = low-income countries.
C.D. Median and interquartile range of the change in protection rates for rice, wheat, and maize in EMDEs (C)
and LICs (D).
subsidized imports of wheat and rice, respectively, to hold down domestic

consumer prices. To avoid subsidizing exports of the same goods, export
restrictions were also introduced. To represent this in the model used here, it is
assumed that, for every good with an import tariff that initially raises import
prices by T0 = (1+t0), there is a flanking export subsidy at rate T0 = (1+t0). The
two measures are assumed to adjust in the same proportion.
The model results suggest that the food price spikes of 2010-11 raised poverty in
most countries, despite widespread government intervention (Figure 7.7; Table
7.1). On average, the share of extreme poor increased by 0.12 percentage point,
FIGURE 7.7 Poverty impact of policies implemented during 2010-11

The 2010-11 food price spike raised global poverty. The combined impact of all
government interventions raised poverty worldwide, except in a few countries. Due to the
dampening effect of interventions on the world price of rice, however, the impact of the
combined interventions is found to have raised poverty about 14 percent less than
individual action.
A. Global poverty impact of a 10 percent rice, B. Global poverty impact of a 10 percent rice,
wheat, and maize price increase wheat, and maize price increase
C. Impact of the 2010-11 food price increase D. Poverty impact of policy responses to the
on the number of extreme poor, by region 2010-11 food price shocks
Source: World Bank staff estimates.

Note: Based on estimates using the MIRAGRODEP computable general equilibrium model described in detail in Annex
7.1. EAP = East Asia and Pacific; LAC = Latin America and the Caribbean; MNA = Middle East and North Africa; SAR =
South Asia; SSA = Sub-Saharan Africa.
A.B. Change in poverty headcount.
C.D. Assuming increases in the price of maize, rice, and wheat as represented in Figure 7.4, panel D, and based on a
poverty line of $1.90/day.
from 13.7 percent. This is equivalent to an additional 8.3 million people, or a 1

percent increase in the number of extreme poor. The increase in world food
prices, combined with government intervention, was most strongly felt in
countries such as India and Uganda, where the extreme poor tend to be net
food buyers, whose real incomes declined.19
19 The results reported here do not take into account the impact of safety net programs, such as India’s
Public Distribution System, which distributes food to poor households at fixed prices and so
automatically makes larger transfers to the poor when food prices rise.
The poverty impact of the 2010-11 food price spike on some regions, such as
East Asia and Pacific and Latin America and the Caribbean, is estimated to be
limited: low rates of poverty combined with the benefits of the price increase for
countries that are heavy exporters of rice (East Asia and Pacific) or maize (Latin
America and the Caribbean) offset some of the losses incurred due to the
increase in prices. Even in Sub-Saharan Africa—the region that accounts for
two-thirds of the global increase in poverty—countries like Ethiopia and
Nigeria implemented insulation policies that reduced poverty.
The results reported here contrast with those of Anderson, Ivanic, and Martin
(2014), who find that during the 2007-08 food price spike, most countries’ own
policies, considered individually, reduced poverty, and the combined effect of all
policy interventions was close to zero. The overall impacts are different because
the 2007-08 price shocks were much larger; the transmission of price changes
from world to domestic markets was assumed to be more pronounced; and there
was a fall in poverty rates over time (the poverty headcount in India, for
instance, fell from 33 to 21 percent).20
Conclusion
The unusual occurrence of two food price spikes in short succession—in
2007-08 and 2010-11—raised concerns about the stability of food markets and
global poverty. During the 2007-08 event, coming after a long period of
relatively stable prices, many countries used trade policies that insulated
domestic food prices from the surge in world prices. Although each country’s
policies can dampen domestic price movements, the result of the combined use
of policies increases global food price volatility. For example, widespread
insulation policies accounted for 40 percent of the increase in world wheat
prices and 25 percent for world maize prices.
The 2010-11 food price rise differed from the 2007-08 price surge in its
economic context, policy responses, and poverty implications. Although the
2007-08 episode was led by rice prices, exacerbated by export restrictions
imposed by major rice producers, the 2010-11 food price surge was led by maize
and wheat prices, triggered by adverse weather events in major wheat and maize
producers in Australia and the Black Sea Basin. During 2007-08, large rice
consumers, such as India, imposed export restrictions to contain domestic rice
price increases. These were gradually unwound over the following years. In
20 There is uncertainty around poverty estimates due to systematic measurement errors in household
surveys, which may bias the poor’s dependence on food purchases (Headey and Martin 2016), and
because sustained periods of higher prices result in declines in poverty (Ivanic and Martin 2014b; Jacoby
2016).
2010-11, some large wheat and maize producers, such as Russia and Ukraine,
also introduced export restrictions and import bans to contain domestic price
pressures.
During the 2007-08 food price spike, the policy interventions of individual
countries helped to reduce poverty (Anderson, Ivanic, and Martin 2014). In
contrast, during the 2010-11 food price spike, individual government policy
responses raised global poverty by 1 percent, about the same amount as the
increase in poverty of these interventions considered collectively.
The 2010-11 food price spike preceded a rise in world hunger and severe food
insecurity between 2014 and 2017, reversing the declining trend observed in the
previous decade. In 2017, the number of undernourished people reached 821
million, up by 5 percent since 2014 and a major step backward in achieving
SDG 2 of eradicating hunger by 2030 (FAO et al. 2018).
The results presented in this chapter highlight that the use of trade policy
interventions to insulate domestic markets from food price shocks compounds
the volatility of international prices and may or may not be effective in
protecting the most vulnerable population groups. Instead, storage policies and
targeted safety net interventions, such as cash transfers, food and in-kind
transfers, and so forth, can mitigate the negative impact of food price shocks
while reducing the economywide distortionary impacts of trade policies.
Additional measures, such as crop and weather insurance, warehouse receipt
systems, commodity exchanges, and futures markets, could also be used as risk
management instruments.
Despite the growing body of literature on food price stabilization policies,

several questions remain to be explored. How can measures that seek to
influence market outcomes—such as trade and storage policies—be combined
with social safety net policies to optimize their development impacts? In a
second-best environment, when trade policy interventions are still used, how can
coordination between countries be improved to reduce their negative effects? We
leave these questions open for future research.
TABLE 7.1 Impact of policy responses to the 2010-11 food price

increase on the number of extreme poor (thousands)
Combined action Individual action
Bangladesh 644.3 628.3
China 42.4 401.7
Ecuador 42.4 45.9
Ethiopia -51.2 41.2
Guatemala 33.8 0.0
Indonesia -13.8 -68.1
India 1,797.2 1,819.7
Kenya 376.9 441.5
Cambodia 15.6 11.6
Sri Lanka 0.0 0.0
Malawi 77.6 172.5
Nigeria -359.8 -150.7
Nicaragua -4.0 -1.5
Nepal 2.1 4.1
Pakistan -211.2 -354.3
Panama -0.9 -1.5
Peru -18.2 -39.7
Rwanda 45.0 47.4
Tanzania 514.4 525.7
Uganda 668.7 550.4
Vietnam 198.7 108.5
Yemen, Rep. -123.5 -233.0
South Africa 0.0 476.0
Zambia 5.8 78.4
Sub-Saharan Africa 6,350.0 6,721.2
Central America 28.9 -3.0
Latin America -476.4 -328.8
Middle East and North Africa -124.2 -226.7
South Asia 2,232.3 2,097.9
Southeast Asia 36.9 14.0
Developed countries -5.5 6.2
Developing countries 8,350.0 9,513.0
World 8,344.5 9,519.2
Source: World Bank staff estimates.

Note: Based on estimates using the computable general equilibrium model MIRAGRODEP, described in detail in Annex
7.1. Assuming increases in the price of maize, rice, and wheat as represented in Figure 7.4, panel D, and based on a
poverty line of $1.90/day.

Error correction model
The analytical framework used to represent the imperfect transmission of

changes in international prices into domestic markets relies on an error
correction model (ECM), as described in Ivanic and Martin (2014b). As noted
by Nickell (1985), this model represents a situation in which policy makers seek
to reduce the costs of change and of being out of equilibrium. A simplified
version of the model used by Ivanic and Martin (2014b), expressed in logs, is as
follow:
∆τ = α (pw - pwt-1) + β [pt-1 - γ pwt-1],
where p represents domestic prices; pw world prices; τ the rate of protection,

approximated by (p-pw); α, α < 0, the coefficient of price insulation ranging from
0 for countries that do not insulate against the rise in world prices, to -1 for
countries that adopt policies that fully insulate domestic markets;
β, β < 0, the cost of being out of equilibrium or the speed with which policies
achieve the target level of protection or policy makers move back toward this
equilibrium after being forced away from it by a shock to world prices; γ
determines the long-run relationship between a country’s protection and the
global level of agricultural protection; and [p t -1 - γ×pwt-1] is the deviation from
the political economy equilibrium. It depends on factors like income levels,
exportable/importable status, the elasticity of import demand, and the share of
real income gains from higher protection that will accrue to politically organized
producers (Anderson 1995; Grossman and Helpman 1994).
The database on Distortions to Agricultural Incentives (Anderson and

Valenzuela 2008; Anderson and Nelgen 2013) is the main data source for
estimating the ECM model. It includes estimates of domestic and world price
levels, which also determine the level of protection. The price data used in the
model capture natural shocks (oil prices, weather events) as well as the impact of
trade policy interventions, the separate impacts of which are not possible to
disentangle. The model is estimated for eight food commodities, with data for
82 countries, of which 26 are advanced economies, 44 emerging market and
developing economies, and 12 low-income countries.
Measuring the extent of trade policy interventions
The approach to quantifying the extent of trade policy interventions builds on

that used in Anderson, Ivanic, and Martin (2014). It is assumed that a primary
shock, such as weather shock, generates an initial change in domestic and world
prices. In attempting to insulate consumers and producers from price increases,

governments make offsetting changes in protection measures, such as the
introduction of export bans or reduction in import duties. These measures, in
turn, reinforce the original shock to world prices. When a country imposes an
export restriction, the availability of food to the rest of the world is reduced, and
this tends to push up the world price. Similarly, when an importing country
reduces its import tariffs, it increases the demand for imports and hence puts
upward pressure on the world price.
The impact of the changes in trade policies can be distinguished from those of
the primary shocks in the following equation:
Σ Si ( i ) + i = Σ Di ( i ),
i i
where Si is supply in region i; Di is demand in region i; i = * 1 + t i is the

domestic price; * is the world price; t i is a country-specific trade barrier, such as
a proportional tariff; and i is a random production shift variable for region i.
Totally differentiating the equation above, rearranging, and expressing the
results in percentage changes yields an expression of the impact of a set of
changes in trade distortions on the world price:
Σi Hi ̂i + Σi (Hiγi - Gi i) Ti
̂ *=
Σi (Gi i - Hi γi)
where *̂ is the proportional change in the international price; ̂i is an exogenous

output shock such as might result from good or bad seasonal conditions; i is
the elasticity of demand in market i; γi is the elasticity of supply in market i; Gi
is the share at world prices of country i in global demand; Hi is the share of
country i in global production, and Ti = (1 + ti).
In other words, the impact on the world price of a change in trade policies in
country i is given as a weighted average of the changes in trade distortions in
different markets, with the weight on region i depending on the importance of
that country in global supply and demand, as well as the responsiveness of its
production and consumption to price changes in the country, as represented by
γi and i .
It is thus assumed that elasticities of demand are equal between countries, that
is, that imported and domestic goods are perfect substitutes, and that there are
no supply responses. Alternatively, the model could allow for differentiation
between imported and domestic products, as well as a limited supply response
(Jensen and Anderson 2017). The result would be an expression with weights
that depend on, for instance, the shares of imports in consumption in each
market. However, the overall result is similar in expressing the change in world
prices as a weighted sum of changes in trade distortions.
To avoid having to deal with difficult-to-interpret interaction terms, all

proportional changes are converted into log changes in Ti, i’s, and as:
̂i = ̂ + Ti
Changes in relative prices are measured as in the Agricultural Incentives database

and capture a wide range of policy measures used to assess agricultural trade
distortions—including tariffs, export subsidies, export taxes, export bans, and
import subsidies.
If products are homogeneous, and a country is small, the change in ∆t

represents the change in the domestic price of the good. Additionally, if Ti is
negative in a period of rising world prices, countries are seeking to insulate their
markets from the increase in prices. If it is positive, policy makers are
compounding the increase in world prices with an increase in protection. This
may be due to the correction of past “errors.” This might occur if domestic
prices fall below policy makers’ desired long-run level, or if policy insulated the
domestic market from world markets and an exogenous shock—such as a
harvest shortfall—has caused the domestic price to rise relative to the world
price. Such insulation patterns have been observed in the maize markets in
many African countries (Chapoto and Jayne 2009).
The MIRAGRODEP model
The analytical framework to measure the poverty implications of the 2010-11

food price spike relies on the MIRAGRODEP model (Laborde, Robichaud, and
Tokgoz 2013), complemented with household surveys for more than 31
countries and 285,000 representative households. MIRAGRODEP is a
dynamic, multicountry, and multisector computable general equilibrium (CGE)
model. The model relies on the Global Trade Analysis Project (GTAP) 9, a
global database for 2011. The GTAP database includes input-output tables
linked by bilateral trade flows for 140 regions (countries or country aggregates)
and 57 sectors. For the purposes of the simulations, these countries and sectors
were aggregated into 31 countries/regions and 15 sectors among which rice,
wheat, and maize are represented separately.
On the supply side, the production function is a Leontief function of value

added and intermediate inputs. The intermediate inputs are represented by a
nested, two-level constant elasticity of substitution (CES) function of all goods.
Based on this, substitutability exists between intermediate goods, but these are
more substitutable when they are in the same category (such as agricultural
inputs or services inputs). Value added is also represented by a nested structure
of CES functions of unskilled labor, land, natural resources, skilled labor, and
capital. This nesting allows the modeler to incorporate some intermediate goods
that are substitutes of factors, such as energy or fertilizers.
On the demand side, a representative consumer is assumed to have a constant

propensity to save. The remaining national income is used for the purchase of
final consumption goods. Consumers’ preferences are represented by a linear
expenditure system–CES function, calibrated based on the U.S. Department of
Agriculture Economic Research Service income and price elasticities to reflect
nonhomothetic demand patterns with changes in revenue. Given an increase in
the price staple foods, such as rice, wheat, or maize, consumers substitute away
to consume other food products. Armington elasticities, which measure the
elasticity of substitution between products of different countries, are drawn from
the GTAP database and are assumed to be the same across regions.
Factor endowments are assumed to be fully employed. The supply of capital

goods is modified each year because of depreciation and investment. New capital
is allocated among sectors according to an investment function. Growth rates of
labor supply are fixed exogenously. Land supply is endogenous and depends on
the real remuneration of land. Skilled labor is the only factor that is perfectly
mobile; unskilled labor is imperfectly mobile between agriculture and
nonagriculture sectors according to a constant elasticity of transformation
function. Unskilled labor’s remuneration in agricultural activities is different
from that of nonagricultural activities. The only factor whose supply is constant
is the natural resources factor. However, it is possible to change the factor
endowment endogenously in the baseline to reflect long-term depletion of
resources with respect to a price trajectory.
The poverty impact is captured through a top-down approach using a data set of
household surveys for more than 31 countries and 285,000 representative
households. The impact of a policy shock on poverty depends on price changes,
the relative reliance of households on the consumption of individual staple
foods, and the net food-buying status of households in different segments of the
distribution (Deaton 1989).
Beyond the standard features of a global dynamic CGE model, the

MIRAGRODEP model includes several improvements: subnational land
markets (agroecological zones or administrative districts) and endogenous land
supply; poverty analysis through a top-down approach for global coverage or a
bottom-up approach (for a subset of countries); the dual-dual approach for
formal/informal and rural/urban labor markets (Stifel and Thorbecke 2003); a

consistent aggregator for trade policies (Laborde, Martin, and van der
Mensbrugghe 2017); differentiated data sets on actual trade and farm policies
and existing policy space for scenario design and endogenous policy responses; a
macro nutrient (calories, fats, and proteins) accounting system based on
FAOSTAT food balance sheets and a global input-output matrix; and a
sensitivity analysis framework based on Monte Carlo simulations.
Although the elasticities of substitution for rice, wheat, and maize used in this
model are higher than for manufactured goods, they are not infinite, as is
assumed using the perfect substitutes model (Thursby, Johnson, and Grennes
1986). This specification has important implications for the economy-wide
analysis and at the household level. Given these assumptions, an increase in the
price of an imported good has a muted impact on the domestic consumer price
of that good. Since with the Armington assumption—imported goods
differentiated based on their country of origin—the composite price of the
consumer good is weighted by the shares of domestic and imported goods, the
impact of a unit change in the world price, or in trade policy, is given by the
share of imports in total consumption. Because the share of imports in total
consumption of staple foods is typically small, the impact of trade policy on
consumer prices is much more muted than under the assumption of perfect
substitution used in Anderson, Ivanic, and Martin (2014). On the production
side, the assumption that each country’s export product is the same as the
products sold domestically means that changes in export trade policies will have
a more direct impact on producer prices if the country is an exporter and not
too large in the markets it supplies.
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APPENDIX
Cross-Country Database of Inflation and Country
Characteristics
The database contains a wide range of inflation measures and key country
characteristics, including macroeconomic and structural variables, for up to 175
countries for 1970-2018. This appendix describes the data sources and definitions of
the variables and their construction in detail.
Measures of inflation
Measures. Data are available for six measures of inflation: headline, food,
energy, and core consumer price index (CPI) inflation; producer price index
(PPI) inflation; and gross domestic product (GDP) deflator changes. The
database also includes headline CPI inflation expectations. Data sources include
Haver Analytics, ILOSTAT, the International Monetary Fund’s (IMF’s)
International Financial Statistics and World Economic Outlook database,
OECDstat, UNdata, and the World Bank’s Development Prospects Group
internal databases.1
Country coverage. Headline inflation data are available for 175 countries,
including 34 advanced economies and 141 emerging market and developing
economies (EMDEs), including 31 low-income countries (LICs). A complete
(balanced) data set of annual data for all six inflation measures is available for 25
countries for 1970-2017, including 20 advanced economies and 5 non-LIC
EMDEs. One- or two-year data gaps are completed through interpolation.
Quarterly data for headline CPI inflation are available for up to 34 advanced
economies and 78 EMDEs, including 5 LICs for 1971:1-2018:2 (of which all
but 7 non-LIC EMDEs have updated data to 2018). A balanced sample with
quarterly data available for 1971:1-2018:2 includes 24 advanced economies and
22 non-LIC EMDEs. Table A.1 provides a breakdown of the number of
countries with data available for every year of the period indicated in the column
title.
Headline inflation. Data are drawn primarily from three databases: Haver
Analytics, OECDstat, and the IMF’s World Economic Outlook. The IMF
Consumer Price Index database has data for its member countries for long time
periods, but with gaps. The ILOSTAT database has coverage of most countries
through 2011, but with some gaps.
1 ILOSTAT is a database maintained by the International Labour Organization. OECDstat includes
data and metadata for countries in the Organisation for Economic Co-operation and Development and
select nonmember economies. UNdata is a database provided by the United Nations.
404 A P P E N D I X I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
Food inflation. Data are drawn from four data sets. The ILOSTAT database on
CPI components is the main source as it has the most comprehensive coverage.
Data for some years are missing and coverage ends in 2011. The IMF Consumer
Price Index database is used to fill data gaps. Haver Analytics provides coverage
for some remaining data gaps. OECDstat covers data for Organisation for
Economic Co-operation and Development (OECD) members and some
nonmembers starting in 1970.
Energy, core, and PPI inflation. Data are primarily drawn from Haver Analytics
(energy, core, and PPI inflation), ILOSTAT (energy), UNdata (energy), and
OECDstat (energy, core, and PPI inflation). Data from these sources are merged
only if there are no large discrepancies in values between the databases. Official
core inflation data are available for 70 countries, including 36 non-LIC EMDEs
and 2 LICs. For the other countries, missing core inflation series are
constructed using CPI weights and inflation in CPI components (Table A.2).
Calculation of core inflation. For the countries for which official measures of
core inflation are unavailable, core inflation series are obtained by subtracting
the contribution of volatile components of CPI (food and energy) from headline
inflation.
For most EMDEs and LICs, monthly energy inflation series are not available.
For these countries, the calculation of core inflation uses the housing, water,
electricity, gas, and other fuels category of the CPI as a proxy for energy
inflation. The following formula is used to calculate core inflation in each
period:
[π - ωF πF - ωE πE ]
Core inflation =
1- ωF - ωE
where π, πF, and πE are the monthly inflation rates for headline, food, and
energy, respectively, and ωF and ωE are the weights for food and energy,
respectively. The weights of the sub-indexes in the total index are obtained from
the IMF Consumer Price Index database as well as OECDstat and Haver
Analytics. The information for the following categories is obtained for 66
countries: food and non-alcoholic beverages; alcoholic beverages, tobacco, and
narcotics; clothing and footwear; housing, water, electricity, gas, and other fuels;
furnishings, household equipment, and routine household maintenance; health;
transport; communication; recreation and culture; education; restaurants and
hotels; and miscellaneous goods and services.
Cyclical and trend inflation. Cyclical and trend inflation series are produced
using the methodology in Stock and Watson (2016). Trend inflation is defined
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S A P P E N D I X 405
as the part of inflation that follows a permanent stochastic trend. Cyclical

inflation is a serially uncorrelated transitory component of inflation.
GDP deflator. For 1970-2017, data are drawn from Haver Analytics,
OECDstat, and the World Economic Outlook database. Quarterly data,
defined as quarter-on-quarter percent change, seasonally adjusted, are available
for 95 countries. Annual data are available for 175 countries.
Inflation expectations. Inflation expectations are from two sources. First, the
survey of professional forecasters on medium- to long-term expectations is
conducted by Consensus Economics multiple times each year. It provides
forecasts for annual average CPI inflation over the next 5-10 years for 46
countries (including in the Euro Area) since 1989. The exceptions are the
Russian Federation and Latin American countries. Their inflation forecasts are
surveyed on an end-of-period (December-to-December) basis. Historical long-
TABLE A.1 Number of countries with available inflation data

Number of countries with data available
Any year during Every year since
1970-2017 1970 1980 1990 2000
Headline inflation
Annual 175 153 154 161 175
Quarterly 172 45 51 64 81
Monthly 163 33 51 63 92
Food inflation
Annual 171 101 105 124 139
Quarterly 163 21 25 31 52
Monthly 164 19 25 30 67
Energy inflation
Annual 167 47 55 70 101
Quarterly 92 18 24 28 51
Monthly 157 13 23 27 61
PPI inflation
Annual 103 45 49 54 74
Quarterly 104 8 35 46 70
Monthly 66 7 14 20 41
Core inflation
Annual 146 44 54 68 96
Quarterly 142 20 28 29 60
Monthly 144 8 24 26 58
GDP deflator
Annual 175 135 137 142 172
Quarterly 96 8 15 24 67
Monthly … … … ... …
Note: ... = data are not available for the full sample period; GDP = gross domestic product; PPI = producer price index.
TABLE A.2 Number of countries with estimates of core inflation

Advanced
EMDEs LICs All countries
economies
Frequency A M A M A M A M
From 1970 25 8 16 0 3 0 44 8
From 1980 26 20 23 2 3 0 52 22
From 1990 28 22 34 3 4 0 66 25
From 2000 32 30 52 23 10 5 94 58
From 2010 33 31 77 58 14 12 124 101
Note: Each entry refers to the number of countries in the respective group for which core inflation data are available for
every year in the period indicated. In addition to countries in the table, official core inflation data are available for 52
countries, including 29 countries from OECDstat and 23 countries from Haver Analytics. The former includes Australia,
Belgium, Colombia, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan,
Luxembourg, Latvia, Mexico, New Zealand, Norway, Poland, the Slovak Republic, Slovenia, Spain, Sweden, Switzerland,
Turkey, the United Kingdom, and the United States. The latter includes Belarus, Brazil, Canada, Chile, China, Costa Rica,
the Dominican Republic, El Salvador, Indonesia, Jordan, Kazakhstan, the Republic of Korea, Malaysia, Nicaragua,
Paraguay, Peru, the Russian Federation, Singapore, South Africa, Tanzania, Thailand, Trinidad and Tobago, and Uganda.
A = annual data; EMDEs = emerging market and developing economies; LICs = low-income countries; M = monthly data.
term consensus forecasts are available from October 1989 for the Group of
Seven and six Western European economies. The data set contains long-term
consensus forecasts for 7 Latin American countries since 1993, and for 12 East
Asia and Pacific countries (excluding Japan) and 14 Eastern European countries
since 1998. Second, the IMF World Economic Outlook database provides five-
year-ahead annual average headline CPI inflation forecasts on a biannual basis
for 47 countries for 1990-2017.
Global commodity price indexes. Global commodity prices and indexes are
available from 1960 from the World Bank’s Pink Sheet of commodity price
data. The following global price indexes are available at monthly, quarterly, and
annual frequencies: agricultural commodity; energy commodity; non-energy
commodity; and food commodity. All indexes are in nominal U.S. dollars,
scaled to 2010 equal to 100.
Measures of country characteristics

This section describes measures of country characteristics available in the
database: macroeconomic variables; monetary policy-related variables; variables
related to global integration; exchange rate variables; and structural variables.
The section also describes the classification of countries. Table A.3 provides
detailed information on each variable, including those related to inflation
discussed in the previous section.
Macroeconomic variables
Gross domestic product (GDP). Annual and quarterly data (quarter-on-quarter,
seasonally adjusted percent change) are available from Haver Analytics and
OECDstat.
Industrial production. Unadjusted and seasonally adjusted series of industrial

production are available from Haver Analytics and OECDstat for 63 countries
at monthly frequency for 1970-2018. Country-specific indexes are rebased to
2010 equal to 100.
Savings. Gross national savings (as a percent of GDP) are computed as gross
disposable income less final consumption expenditures after taking into account
an adjustment for pension funds, when possible. These series are available from
the IMF’s World Economic Outlook database for around 170 countries for
1980-2017.
Investment. Investment is expressed as a percent of GDP. Investment or gross

capital formation is measured by the total value of gross fixed capital formation
and changes in inventories and acquisitions less disposals of valuables. It is
available from the IMF’s World Economic Outlook database for 173 countries
for 1980-2017.
Gross public debt. This measure is defined as gross public debt as a percentage
of GDP. It uses four data sources for constructing debt-to-GDP ratios. Mauro et
al. (2015) provide a historical data set of government debt for 55 countries for
1800-2011. Abbas et al. (2011) provide a comprehensive database of gross
central government debt-to-GDP ratios, covering 174 countries for 1700-2012.
Data are updated to 2017 using the IMF Historical Public Debt Database and
World Economic Outlook database.
Fiscal rules. A fiscal rule imposes a long-lasting constraint on fiscal policy

through numerical limits on budgetary aggregates. The IMF Fiscal Rules
Dataset 1985-2015 (Schaechter et al. 2012) provides systematic information on
the use and design of fiscal rules covering national and supranational fiscal rules
in 96 countries from 1985 to 2015. The data set covers four types of rules:
budget balance rules, debt rules, expenditure rules, and revenue rules, applying
to the central or general government or the public sector. It also presents details
on various characteristics of rules, such as their legal basis, coverage, escape
clauses, as well as enforcement procedures, and takes stock of key supporting
features that are in place, including independent monitoring bodies and fiscal
responsibility laws.
Monetary policy–related variables
Monetary policy framework. This variable classifies the monetary policy regimes
into those with exchange rate anchors, monetary aggregate targets, inflation
targeting frameworks, and other (hybrid) regimes. It is available for 197
countries from 1990. The main sources are the IMF Quarterly Report on
Exchange Arrangements and the IMF Annual Report on Exchange Arrangements
and Exchange Restrictions (AREAER). The database includes the following

categories:
• Monetary aggregate targeting
• Inflation targeting regimes
• Free floating without inflation targeting regimes (including all Euro Area
countries)
• Exchange rate anchor, U.S. dollar (including the Eastern Caribbean

Currency Union)
• Exchange rate anchor, euro (including the West African Economic and
Monetary Union and Central African Economic and Monetary
Community)
• Exchange rate anchor, composite
• Exchange rate anchor, other currency.
Inflation targeting framework. The IMF’s AREAER provides country-specific

information on inflation targeting frameworks starting from 2010. It describes
the de jure monetary policy regime as declared by the national monetary
authorities. An electronic version of the data is provided by Caceres, Carrière-
Swallow, and Gruss (2016). For countries with inflation targets, the data set
provides the month and year of adoption of the inflation targeting framework.
Because AREAER (and its online version) only provides information on
inflation targeting frameworks since 2010, information from Carare and Stone
(2006) is used to determine the exact year each country adopted inflation
targeting. This variable is available for up to 170 countries for 1990-2017 on a
monthly, quarterly, and annual basis.
Inflation targets. Information on “inflation target” ranges is available on a

monthly basis for 37 countries from 1990. The data include three variables: the
midpoint as well as the upper and lower bounds of inflation target ranges. For
ease of analysis, for those countries that target a midpoint and do not have an
official upper and lower bound, a range adding ±1 is calculated as the target
range. Similarly, for those countries that do not have a midpoint for their
inflation target, and instead target only a range, the midpoint was assumed to be
the average of the lower and upper bounds of the announced target range. The
data sources include national central banks, the Central Bank News website,
AREAER database, and other sources.
Central bank independence. The measure of central bank independence relies

on two sources. Garriga (2016) includes annual data on de jure central bank
independence for 182 countries for 1970-2012. The data set identifies statutory
reforms affecting central bank independence and their impact. Dincer and
Eichengreen (2014) measure transparency and independence for about 120
central banks spanning 1998-2014. The index ranges from 0 to 15. The Dincer-
Eichengreen index is selected as the main measure of central bank independence
because it is available over a long timeframe (1998-2014). To expand the
sample, the index is extrapolated to 2015-17 using 2014 data and extrapolated
to 1970-97 using 1998 data. For countries not included in the Dincer and
Eichengreen (2014) data set, the fitted values from an ordinary least squares
regression of the Dincer-Eichengreen index on the Garriga index are used.
Central bank head turnover. Central bank head turnover data are available from
Dreher, Sturm, and de Haan (2010). This data set contains information on the
term in office and month and year at which a central bank governor is replaced.
It also provides the official term in office according to the central bank law for
159 countries covering 1970-2014. The turnover rate (number of changes in
central bank heads before the end of his or her legal term in office) using a four-
year rolling average preceding a central bank governor change is calculated
(similar to Klomp and de Haan [2010]). The four-year window matches the
average turnover rate of central bank governors.
Variables related to global integration

De jure financial openness. Three sources are used to measure financial
openness. Quinn and Toyoda (2008) have a capital controls index database of
de jure measures of capital account and financial current account openness for
94 countries over 1980-2014. Fernandez et al. (2016) have a capital control
measures data set of restrictions on capital account inflows and outflows for 10
categories of assets for 100 countries between 1995 and 2013. Chinn and Ito
(2006) provide a de jure measure of capital account openness for 182 countries
between 1970 and 2016. The annual and quarterly data sets contain all three
measures of financial openness. To obtain the widest possible coverage, the
primary source of financial openness is the Chinn-Ito index.
De facto financial openness. International financial integration provides a proxy

for de facto financial openness. It is measured as the sum of foreign assets and
liabilities as a percentage of GDP in current U.S. dollars. The External Wealth
of Nations Mark II database (Lane and Milesi-Ferretti 2007) is the main source
of financial integration data through 2014. Data from the IMF’s Balance
of Payments and International Investment Position Statistics are used to
expand cross-country coverage. Data are available for 128 countries for the
period since 1976.
Participation in global value chains (GVCs). Three measures of GVC

participation are provided: backward and forward participation and the
intermediate trade share of GDP. Backward participation in GVCs measures

the foreign value added embodied in a country’s exports, as a percentage of total
gross exports. Forward participation in GVCs measures a country’s value added
embodied in foreign exports, as a percentage of total gross exports. Both data
series are available from the OECD–World Trade Organization Trade in Value
Added database for 58 countries for 1995, 2000, 2005, and 2008-11. The series
of intermediate trade share of GDP are defined as the sum of intermediate
imports and exports, as a percentage of GDP. Data are available for up to 166
countries, but with uneven year coverage. For 1988-2016, the series are
available for 137 countries. Data are taken from the World Bank’s World
Integrated Trade Solution (WITS) and World Development Indicators. These
three data series are used to construct a dummy variable indicating high
participation in GVCs. A country is classified as highly integrated into GVCs
(the dummy is assigned the value 1) if one of two conditions is met: the sum of
backward and forward participation in GVCs is greater than the median of the
sample in a particular year, or the intermediate trade ratio is greater than the
median of the sample in a particular year.
Trade openness. The indicator for trade openness is defined as the sum of
exports and imports of goods and services as a percentage of GDP. Data are
available for 170 countries for 1970-2017, taken from the World Bank World
Development Indicators. Data gaps are filled with data on exports, imports, and
GDP obtained from the IMF’s World Economic Outlook database.
Average effective tariff. This measure is the average rate of effectively applied
tariffs, weighted by the product import shares corresponding to each partner
country. Data are classified using the UN Harmonized System of trade at the
six- or eight-digit level. This variable is available from the WITS website for a
maximum of 149 countries, but with uneven year coverage; it is available for
109 countries for 2000-16.
Exchange rate variables
Bilateral exchange rate against the U.S. dollar. The IMF’s International
Financial Statistics database provides exchange rates in national currencies per
U.S. dollar. Exchange rates in the database are classified into three broad
categories, reflecting the role of the authorities in determining the rates and/or
the multiplicity of the exchange rates in a country. The three categories are the
market rate, describing an exchange rate determined largely by market forces;
the official rate, describing an exchange rate determined by the authorities—
sometimes in a flexible manner; and the principal, secondary, or tertiary rate,
for countries maintaining multiple exchange arrangements. Data for the market
exchange rate against the U.S. dollar are available for 34 advanced economies
and 137 EMDEs, including 30 LICs, for 1970-2018.
Nominal and real effective exchange rates. The nominal and real effective
exchange rates rely primarily on Darvas (2012). The database includes annual
and monthly data for 178 countries, considerably more than in any other
publicly available database. The series are available through mid-2017. The
annual database covers 171 countries over 1960-2017, and the monthly database
includes data for 165 countries over 1970-2017.
De facto exchange rate regime. The exchange rate regime classification of

Shambaugh (2004) is used to determine whether a country has a pegged or
flexible exchange rate. The original classification has four categories: “1” reflects
no fluctuation at all; “2” indicates movements within 1 percent bands; “3”
indicates movements within 2 percent bands; and “4” indicates a one-time
devaluation with no change in the remaining 11 months of the year. Shambaugh
(2004) assesses these movements against relevant base currencies. The
constructed dummy variable indicating a pegged exchange rate regime is defined
to equal 1 for countries classified as 1, 2, 3, or 4. A value of 0 is assigned to
flexible exchange rates—that is, exchange rates that routinely fluctuate outside a
2 percent band. The indicator is available on an annual basis for 176 countries
for 1960-2014.
De jure exchange rate regime. An alternative measure of the exchange rate

regime is taken from Ilzetzki, Reinhart, and Rogoff (2017). They present annual
and monthly data for 194 countries for 1946-2016. The classification includes
the following categories:
1. No separate legal tender or currency union
2. Pre-announced peg or currency board arrangement
3. Pre-announced horizontal band that is narrower than or equal to ± 2 percent
4. De facto peg
5. Pre-announced crawling peg; de facto moving band narrower than or equal

to ± 1 percent
6. Pre-announced crawling band that is narrower than or equal to ± 2 percent

or de facto horizontal band that is narrower than or equal to ± 2 percent
7. De facto crawling peg
8. De facto crawling band that is narrower than or equal to ± 2 percent
9. Pre-announced crawling band that is wider than or equal to ± 2 percent
10. De facto crawling band that is narrower than or equal to ± 5 percent

11. Moving band that is narrower than or equal to ± 2 percent (that is, allows
for appreciation and depreciation over time)
12. De facto moving band ± 5 percent / managed floating
13. Freely floating
14. Freely falling
15. Dual market in which parallel market data are missing.
All countries with classification categories 1 to 11 are considered fixed exchange

rate regimes and assigned a value of 1. Categories 12 to 15 are treated as flexible
exchange rate regimes and assigned a value of 0.
Structural variables
Demographic variables. Population growth is the average annual growth of
midyear population. It is available for 209 countries for 1970-2017 and
obtained from the World Bank World Development Indicators. The old-age
dependency ratio measures the ratio of people older than 64 years as a percent
age of the working-age population (ages 15 to 64 years). The young-age
dependency ratio is the share of people younger than 15 years as a percentage of
the working-age population. The dependency ratios are also collected from the
World Bank World Development Indicators and are available for 189 countries
for 1970-2017.
Labor market flexibility. The labor market flexibility indicator uses the Fraser
Institute’s Economic Freedom of the World database. The labor market
flexibility index uses survey responses to construct labor market flexibility
indicators in four areas: minimum wage, hiring and firing practices, collective
bargaining, and unemployment benefits. The survey asks respondents to answer
questions on a scale from 1 (disagree) to 7 (agree), where 7 indicates strongest
agreement. The index is standardized on a 0-10 scale. A higher value represents
a more flexible labor market. Data are available for 152 countries for every five-
year period between 1980 and 2000, and annually for 2001-14 (Gwartney,
Lawson, and Hall 2017).
Collective bargaining coverage rate. The collective bargaining coverage rate is

an indicator of the degree to which wages and working conditions are regulated
by collective agreements. It measures the number of workers in employment
whose pay and/or conditions of employment are determined by one or more
collective agreements as a proportion of all those who are eligible to conclude a
collective agreement. The collective bargaining coverage rate is available from
ILOSTAT for 62 countries from 2001 to 2013.
Trade union density rate. Trade union membership, defined as the total
number of workers who belong to a trade union, can be an indicator of trade
union strength. The trade union density rate expresses union membership as a
proportion of the eligible workforce and can be used as an indicator of the
degree to which workers are organized. Data for this measure are available from
ILOSTAT for 49 countries for 2000-13.
Rainfall. Rainfall data, defined as precipitation in millimeters per month, come
from the Climate Change Knowledge Portal. The data set is produced by the
Climatic Research Unit of the University of East Anglia and reformatted by the
International Water Management Institute. It contains historical precipitation
data aggregated from 2-degree gridded data to the country and basin levels. It is
derived from observational data and provides quality-controlled temperature and
rainfall values from thousands of weather stations worldwide, as well as
derivative products, including monthly climatologies and long-term historical
climatologies. The data cover more than 180 countries for 1901-2017.
Country classification
Country groups. Advanced economies include Australia; Austria; Belgium;
Canada; Cyprus; the Czech Republic; Denmark; Estonia; Finland; France;
Germany; Greece; Hong Kong SAR, China; Iceland; Ireland; Israel; Italy; Japan;
the Republic of Korea; Latvia; Lithuania; Luxembourg; Malta; the Netherlands;
New Zealand; Norway; Portugal; Singapore; the Slovak Republic; Slovenia;
Spain; Sweden; Switzerland; the United Kingdom; and the United States.
Emerging market and developing economies (excluding low-income countries)
include Albania; Algeria; Angola; Antigua and Barbuda; Argentina; Armenia;
Azerbaijan; The Bahamas; Bahrain; Bangladesh; Barbados; Belarus; Belize;
Bhutan; Bolivia; Bosnia and Herzegovina; Botswana; Brazil; Brunei Darussalam;
Bulgaria; Cabo Verde; Cambodia; Cameroon; Chile; China; Colombia; the
Republic of Congo; Costa Rica; Côte d’Ivoire; Croatia; Djibouti; Dominica; the
Dominican Republic; Ecuador; the Arab Republic of Egypt; El Salvador;
Equatorial Guinea; Eswatini; Fiji; Gabon; Georgia; Ghana; Grenada;
Guatemala; Guyana; Honduras; Hungary; India; Indonesia; the Islamic
Republic of Iran; Iraq; Jamaica; Jordan; Kazakhstan; Kenya; Kiribati; Kuwait;
the Kyrgyz Republic; the Lao People’s Democratic Republic; Lebanon; Lesotho;
Libya; the former Yugoslav Republic of Macedonia; Malaysia; Maldives; the
Marshall Islands; Mauritania; Mauritius; Mexico; the Federated States of
Micronesia; Moldova; Mongolia; Montenegro; Morocco; Myanmar; Namibia;
Nauru; Nicaragua; Nigeria; Oman; Pakistan; Palau; Panama; Papua New
Guinea; Paraguay; Peru; the Philippines; Poland; Qatar; Romania; the Russian
Federation; Samoa; São Tomé and Príncipe; Saudi Arabia; Serbia; the
Seychelles; the Solomon Islands; South Africa; Sri Lanka; St. Kitts and Nevis; St.
Lucia; St. Vincent and the Grenadines; Sudan; Suriname; Thailand; Tonga;
Trinidad and Tobago; Tunisia; Turkey; Turkmenistan; Tuvalu; Ukraine; the
United Arab Emirates; Uruguay; Uzbekistan; Vanuatu; República Bolivariana de
Venezuela; Vietnam; and Zambia.
Low-income countries include Afghanistan; Benin; Burkina Faso; Burundi; the
Central African Republic; Chad; the Comoros; the Democratic Republic of
Congo; Eritrea; Ethiopia; The Gambia; Guinea; Guinea-Bissau; Haiti; the
Democratic People’s Republic of Korea; Liberia; Madagascar; Malawi; Mali;
Mozambique; Nepal; Niger; Rwanda; Senegal; Sierra Leone; Somalia; South
Sudan; the Syrian Arab Republic; Tajikistan; Tanzania; Togo; Uganda; the
Republic of Yemen; and Zimbabwe. The classification of LICs is based on the
World Bank Group classification as of June 2018.
Commodity exporter status. A country is classified as a “commodity exporter” if
one of the following two conditions was met during 2012-14: on average,
commodity exports accounted for 30 percent or more of total goods exports, or
exports of any single commodity accounted for 20 percent or more of total
goods exports. Economies for which these thresholds were met because of re-
exports were excluded. When data were not available, judgment was used. This
taxonomy results in the classification of some well-diversified economies as
importers, even if they are exporters of certain commodities (for example,
Mexico). Commodity importers are all economies that are not classified as
commodity exporters.
Regions. Regional dummy variables for East Asia and Pacific, Europe and
Central Asia, Latin America and the Caribbean, Middle East and North Africa,
South Asia, and Sub-Saharan Africa follow the World Bank Group classification.
Net food importer status. Net food importers are classified based on net food
imports (food imports minus food exports) as a percentage of GDP. Food
comprises the commodities in sections 0 (food and live animals), 1 (beverages
and tobacco), and 4 (animal and vegetable oils and fats), as well as division 22
(oil seeds, oil nuts, and oil kernels) in the UN Standard International Trade
Classification. A country is classified as a net food importer (the dummy is
assigned the value 1) if its net food imports as a percentage of GDP are above
the median of net food imports across countries in a given year.
Net energy importer status. Net energy importers are classified based on net
fuel imports (fuel imports minus fuel exports) as a percentage of GDP. A
country is classified as a net energy importer (the dummy is assigned the value 1)
if its net fuel imports as a percentage of GDP are above the median of net fuel
imports across countries in a given year.
TABLE A.3 Database
Variable name Country Year

Description Units Source
in database coverage coverage
Central bank websites;

Consumer price From
inflation Percent 175 IMF IFS; Haver Analytics;
inflation 1970
OECDstat

Producer price From
ppi Percent 103 IFS; Haver Analytics;
inflation 1970
OECDstat
Core consumer From
core_inf Percent 145 IFS; ILOSTAT; Haver
price inflation 1970
Analytics; OECDstat
GDP deflator From
deflator_gdp Percent 175 IFS; Haver Analytics;
change 1970
OECDstat
Food and ILOSTAT database on
non-alcoholic CPI Components; IMF
From
food_inf beverages Percent 171 Consumer Price Index
1970
consumer price database; Haver
inflation Analytics; OECDstat
Energy Central bank websites;
From
energy consumer price Percent 167 Haver Analytics;
1970
inflation ILOSTAT; OECDstat
Global energy
From World Bank Pink Sheet
co_energy commodity price Percent 175
1970 commodity price data
inflation
Global non-
co_non_energ energy From World Bank Pink Sheet
Percent 175
y commodity price 1970 commodity price data
inflation
Food commodity From World Bank Pink Sheet
co_food Percent 175
price inflation 1970 commodity price data
Dummy
De facto
variable; From Shambaugh (2004); IMF
pegtype_bi exchange rate 168
1=fixed, 1970 AREAER
regime
0=flexible
Dummy
De jure
variable; From Ilzetzki, Reinhart, and
xr_regime exchange rate 169
1=fixed, 1970 Rogoff (2017)
regime
0=flexible
Index;
0=least
Central bank 1998- Dincer and Eichengreen
cbi_trans transparent; 108
transparency 2014 (2014)
15=most
transparent
Index;
Central bank 0=least
From cbi_trans extended using
cbi_trans_fit transparency, transparent; 165
1970 Garriga (2016)
extended sample 15=most
transparent
Gross national Percent of From IMF World Economic
saving_wdi 169
savings GDP 1980 Outlook
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. AREAER =
Annual Report on Exchange Arrangements and Exchange Restrictions; CPI = consumer price index; GDP = gross domes-
tic product; IFS = International Financial Statistics; IMF = International Monetary Fund.
TABLE A.3 Database (continued)

Variable
Country Year
name Description Units Source
coverage coverage
in database
Dummy variable:
2=Monetary aggregate
targeting
3=Inflation targeting
regimes
4=Free floating without
inflation targeting regimes
(including all Euro Area
Monetary
countries)
policy From IMF AREAER
mon_policy 11= Exchange rate anchor, 175
framework 1990
U.S. dollar (including
ECCU)
12= Exchange rate anchor,
euro (including WAEMU
and CEMAC)
13= Exchange rate anchor,
composite
14=Exchange rate anchor,
other currency
IMF AREAER;
Presence of
Carare and Stone
inflation Dummy variable;
From (2006);
IT targeting 1=inflation targeting; 0=not 175
1970 Caceres, Carriere-
framework inflation targeting
Swallow, and
Gruss (2016)
Number of changes in
Central Dreher, Sturm,
central bank heads before
TOR_i bank head 143 From 970 and de Haan
the end of his or her legal
turnover (2010)
term in office
Dummy variables; CMA of
Commodity
1=commodity importers;
importer World Bank
CMA of 0=otherwise; From
CMA, CXA and 175 Global Economic
CXA of 1=commodity 1970
exporter Prospects reports
exporter; CXA of
status
0=otherwise
EAP=East Asia and Pacific;
ECA=Europe and Central
Asia; LAC=Latin America
EMDE and the Caribbean; From World Bank Group
region 175
regions MNA=Middle East and 1970 classification
North Africa; SAR=South
Asia; SSA=Sub-Saharan
Africa
Income
groups
AE=advanced economies;
incomegro AEs (31), From World Bank and
EMDE=non-LIC EMDEs; 175
up EMDEs 1970 IMF classification
LIC=low-income countries
(110), LICs
(31)
Gross
From IMF World
saving_wdi national Percent of GDP 169
1980 Economic Outlook
savings
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. AEs = ad-
vanced economies; AREAER = Annual Report on Exchange Arrangements and Exchange Restrictions; CEMAC = Central
African Economic and Monetary Community; ECCU = Eastern Caribbean Currency Union; EMDEs = emerging market and
developing economies; GDP = gross domestic product; LICs = low-income countries; WAEMU = West African Economic
and Monetary Union.

Variable
Country Year
coverage coverage
in database
“it” refers to Inflation
target, mid-point
National central bank
target, or average of
websites;
target range;
Central Bank News
it, it_lower, “it_upper” refers to From
Percent 38 website;
it_upper upper bound of 1990
IMF AREAER; other
target range; and
documents
“it_lower” refers to
lower bound of
target range
Index;
De jure financial 0=least
From
cap100_new openness (Quinn- open; 122 Quinn and Toyoda (2008)
1970
Toyoda Index) 100=most
open
Index;
De jure financial 0=least
ka_open_ne From
openness (Chinn-Ito open; 173 Chinn and Ito (2006)
w 1970
Index) 1=most
open
De Jure Financial
Openness
Capital Control
Measures data set of Index;
restrictions on 0=least
From
ka_new capital account open; 99 Fernandez et al. (2016)
1995
inflows and outflows 1=most
for 10 categories of open
assets for 100
countries between
1995 and 2013
De facto financial
Lane and Milesi-Ferretti
openness, defined
2007; IMF Balance of
as the sum of Percent of From
fin_int 175 Payments and
international assets GDP 1970
International Investment
and liabilities in
Position Statistics
percent of GDP
Backward
participation in 1995,
GVCs, defined as 2000,
back_gvc foreign value added Percent 58 2005, OECD-WTO TiVA
in domestic exports and 2008
in percent of total -11
domestic exports
Forward participation
in GVCs, defined as 1995,
domestic value 2000,
for_gvc added embodied in Percent 58 2005, OECD-WTO TiVA
foreign exporters, as and
percent of foreign 2008-11
exports
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. AREAER =
Annual Report on Exchange Arrangements and Exchange Restrictions; GDP = gross domestic product; GVCs = global
value chains; IMF = International Monetary Fund; OECD = Organisation for Economic Co-operation and Development;
TiVA = Trade in Value Added; WTO = World Trade Organization.

Variable
Country Year
coverage coverage
in database
1995,
Sum of intermediate exports WITS; World
Percent 2000,
gvc_total and imports as percent of 58 Development
of GDP 2005, and
GDP Indicators
2008-11
High integration into global
value chains, defined as
one of two conditions being
Dummy
met: the sum of backward
variable;
and forward participation in
1=highly Constructed from
global value chains is From
gvc_dummy integrated 175 back_gvc, for_gvc,
greater than the median of 1970
; 0=not and gvc_total
the sample in a particular
highly
year, or the intermediate
integrated
trade ratio is greater than
the median of the sample in
a particular year
World Development
Sum of exports and imports
Percent of From Indicators; IMF
trade_open of goods and services as 175
GDP 1970 World Economic
percent of GDP
Outlook
Average effective tariff,
weighted by product-level 1988-
tariff Percent 166 WITS
import share from each 2016
partner country
Abbas et al. (2011);
Mauro et al. (2015);
Gross public debt as Percent of From IMF Historical Public
debt_gdp 175
percent of GDP GDP 1970 Debt Database; IMF
World Economic
Outlook
Index,
Nominal effective exchange various From
neer 171 Darvas (2012)
rate base 1970
years
Nominal effective exchange Index, From

neer_index 171 Darvas (2012)
rate, rebased to 2007 2007=100 1970
Average annual growth of From World Development

pop_growth Percent 173
midyear population 1970 Indicators
Old-age dependency ratio,
defined as number of Percent of
people older than 64 as working- From World Development
old_dep 171
percent of the working-age age 1970 Indicators
population (ages 15 to 64 population
years)
Index;
0=least Fraser Institute
flexibility
Labor market flexibility flexible; 152 2001-14 Economic Freedom
10=most of the World
flexible
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017.
GDP = gross domestic product; IMF = International Monetary Fund; WITS = World Integrated Trade Solution.

Variable
name Country Year
in coverage coverage
database
Net food imports, defined as food
imports minus food exports as
percent of GDP. Food comprises
the commodities in SITC sections 0 World
Percent of From
foodnet (food and live animals), 1 167 Development
GDP 1970
(beverages and tobacco), and 4 Indicators
(animal and vegetable oils, and
fats), as well as SITC division 22
(oil seeds, oil nuts, and oil kernels).
Dummy
variable;
High net food importer status 0=net food
defined as net food imports as imports below
foodnet_d percent of GDP above the median cross-country From Constructed
140
um of net food imports across median; 1=net 1970 from foodnet
countries in a given year food imports
above cross-
country
median
Net fuel imports, defined as fuel World
Percent of From
energynet imports minus fuel exports as 167 Development
GDP 1970
percent of GDP Indicators
Dummy
variable;
High net energy importer status 0=net fuel
defined as net fuel imports in imports below
Constructed
energynet percent of GDP above the median cross-country From
140 from
_dum of net fuel imports across countries median; 1=net 1970
energynet
in a given year fuel imports
above cross-
country
median
Young dependency ratio, defined
Percent of World
young_de as number of people younger than From
working-age 171 Development
p 15 as percent of the working-age 1970
population Indicators
population (ages 15 to 64 years)
Collective bargaining coverage,
defined as the number of workers
Percent of
in employment whose pay and/or
workers
conditions of employment are
bargainin eligible to
determined by one or more 62 2001-13 ILOSTAT
g conclude a
collective agreements as a
collective
proportion of all those who are
agreement
eligible to conclude a collective
agreement
IMF World
Percent of From
inv Gross capital formation 162 Economic
GDP 1980
Outlook
Dummy
variable;
Yes=fiscal
fiscal_rul rule has been 1985- Schaechter et
Adoption of a fiscal rule 92
e adopted; 2015 al. (2012)
No=no fiscal
rule has been
adopted
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. GDP = gross
domestic product; IMF = International Monetary Fund; SITC = Standard International Trade Classification.

Weight of energy
in the consumer
price index; OECDstat;
when Haver Analytics;
From
ener_weight unavailable, Percent 143 IMF International
1970 Financial
weight of
housing, water, Statistics
electricity, and
gas
Weight of food
and non- OECDstat;
Haver Analytics;
alcoholic From
food_weight Percent 145 IMF International
beverages in the 1970 Financial
consumer price Statistics
index
Crude oil price
World Bank Pink
(unweighted
U.S. dollars per From Sheet
crude_petro average of 170
barrel 1970 commodity price
Dubai, Brent, data
and WTI prices)
Crude oil price
(unweighted
World Bank Pink
average of
U.S. dollars per From Sheet
kcrude_petro Dubai, Brent, 170
barrel 1970 commodity price
and WTI prices) data
at constant 2005
U.S. dollars
IMF World
GDP in billions Billions of U.S. From
gdp_weo 169 Economic
of U.S. dollars dollars 1980
Outlook
IMF World
gdp_growthwe Real GDP From
Percent 174 Economic
o growth 1981
Outlook
PPP valuation of
IMF World
country GDP, in Billions of U.S. From
pppgdp_weo 169 Economic
billions of U.S. dollars 1980
Outlook
dollars
Trade union
density rate,
defined as union
Percent of the
union membership as 75 2000-13 ILOSTAT
eligible workforce
a proportion of
the eligible
workforce
Trend
component of
inflation, From World Bank
trend Percent 148
estimated as in 1970 estimates
Stock and
Watson (2016)
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. GDP = gross
domestic product; IMF = International Monetary Fund; WTI = West Texas Intermediate.

Cyclical component of
inflation, estimated as
cycle Percent 148 From 1970 World Bank estimates
in Stock and Watson
(2016)
Variance of trend
component of inflation,
var_trend Percent 148 From 1970 World Bank estimates
estimated as in Stock
and Watson (2016)
Variance of cyclical
component of inflation,
var_cycle Percent 148 From 1970 World Bank estimates
estimated as in Stock
and Watson (2016)
Quarter-on-quarter, Haver Analytics;
seasonally adjusted, OECDstat; IMF
inflation_qoq Percent 111 From 1970
annualized CPI International Financial
inflation Statistics
Haver Analytics;
Year-on-year, CPI OECDstat; IMF
inflation_q Percent 172 From 1970
inflation International Financial
Statistics
ILOSTAT database on
Quarter-on-quarter,
CPI Components; IMF
seasonally adjusted,
food_qoq Percent 163 From 1970 Consumer Price Index
annualized food CPI
database; Haver
inflation
Analytics; OECDstat
Quarter-on-quarter,
Haver Analytics;
seasonally adjusted,
energy_qoq Percent 92 From 1970 ILOSTAT; UNdata;
annualized energy CPI
OECDstat.
inflation
Quarter-on-quarter,
seasonally adjusted, Haver Analytics;
ppi_qoq Percent 103 From 1970
annualized PPI OECDstat
inflation
Quarter-on-quarter, Haver Analytics;
seasonally adjusted, OECDstat; IMF
core_qoq Percent 142 From 1970
annualized core CPI International Financial
inflation Statistics
Quarter-on-quarter,
Haver Analytics;
deflator seasonally adjusted, Percent 96 From 1970
OECDstat
GDP deflator
Consumer price index,
headline month-on-month Percent 170 From 1970 Haver Analytics
inflation rate
ILOSTAT database on
Food and non- CPI Components;
alcoholic beverages IMF Consumer Price
food Percent 169 From 1970
price index, month-on- Index database;
month inflation rate Haver Analytics;
OECDstat
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017. CPI = con-
sumer price index; GDP = gross domestic product; IMF = International Monetary Fund; PPI = producer price index.

Haver Analytics;
Core inflation, OECDstat; IMF
From
Core month-on-month Percent 112 International
1970
inflation rate Financial Statistics;
calculated
OECDstat; Haver
From Analytics; IMF
core_inflation Official core inflation Percent 56
1970 International
Financial Statistics
Global energy World Bank Pink

Index, From
g_energy commodity prices 181 Sheet commodity
2010=100 1970 price data
(nominal U.S. dollars)
Global non-energy World Bank Pink

g_non_energ Index, From
commodity prices 169 Sheet commodity
y 2010=100 1970
(nominal U.S. dollars) price data
Global food World Bank Pink

Index, From
g_food commodity prices 169 Sheet commodity
2010=100 1970 price data
(nominal U.S. dollars)
Precipitation
1990- Climate Change
rainfall Rainfall in millimeters 167
2016 Knowledge Portal
per month
Haver Analytics;
Index, From OECDstat; IMF
ind_pro Industrial production 60
2010=100 1970 International
Haver Analytics;
Industrial production, Index, From OECDstat; IMF
ind_pro_sa 34
seasonally adjusted 2010=100 1970 International
Haver Analytics;
Local
From OECDstat; IMF
m3 Money supply M3 currency 74
1980 International
units
Haver Analytics;
Local
Base money, local From OECDstat; IMF
base_money currency 42
currency 1980 International
units
Local Haver Analytics;

Broad money, local
broad_money currency 126 2001-17 OECDstat; IMF
currency
units International
Note: Country coverage indicates the number of countries with data available in any year during 1970-2017.
References
Abbas, S. M. A., N. Belhocine, A. El-Ganainy, and M. Horton. 2011. “Historical Patterns
and Dynamics of Public Debt—Evidence from a New Database.” IMF Economic Review 59
(4): 717-42.
Caceres, C., Y. Carrière-Swallow, and B. Gruss. 2016. “Global Financial Conditions and
Monetary Policy Autonomy.” IMF Working Paper 16/108, International Monetary Fund,
Washington, DC.
Carare, A., and M. R. Stone. 2006. “Inflation Targeting Regimes.” European Economic Review
50 (5): 1297-315.
Controls, Institutions, and Interactions.” Journal of Development Economics 81(1): 163-92.
Darvas, Z. 2012. “Real Effective Exchange Rates for 178 Countries: A New Database.”
Bruegel Working Paper 2012/06, Bruegel, Brussels.
Dreher, A., J.-E. Sturm, and J. de Haan. 2010. “When Is a Central Bank Governor Replaced?
Evidence Based on a New Data Set.” Journal of Macroeconomics 32 (3): 766-81.
Fernández, A., M. W. Klein, A. Rebucci, M. Schindler, and M. Uribe. 2016. “Capital

Control Measures: A New Dataset.” IMF Economic Review 64 (3): 548-74.
Garriga, A. C. 2016. “Central Bank Independence in the World: A New Dataset.”

International Interactions 42 (5): 849-68.
Gwartney, J., R. Lawson, and J. Hall. 2017. Economic Freedom of the World: 2017 Annual
Report. Vancouver: Fraser Institute.
Ilzetzki, E., C. Reinhart, and K. S. Rogoff. 2017. “Exchange Arrangements Entering the 21st
Century: Which Anchor Will Hold?” NBER Working Paper 23134, National Bureau of
Klomp, J., and J. de Haan. 2010. “Central Bank Independence and Inflation Revisited.”
Public Choice 144 (3-4): 445-57.
Lane, P. R., and G. M. Milesi-Ferretti. 2007. “The External Wealth of Nations Mark II:
Revised and Extended Estimates of Foreign Assets and Liabilities,1970-2004.” Journal of
Mauro, P., R. Romeu, A. Binder, and A. Zaman. 2015. “A Modern History of Fiscal
Prudence and Profligacy.” Journal of Monetary Economics 76: 55-70.
Quinn, D. P., and A. M. Toyoda. 2008. “Does Capital Account Liberalization Lead to
Growth?” Review of Financial Studies 21 (3): 1403-49.
Schaechter, A., T. Kinda, N. Budina, and A. Weber. 2012. “Fiscal Rules in Response
to the Crisis—Toward the ‘Next-Generation’ Rules: A New Dataset.” IMF Working Paper
Stock, J. H., and M. W. Watson. 2016. “Core Inflation and Trend Inflation.” Review of
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S INDEX OF TERMS 425
INDEX
A Commodity exporters
exchange rate appreciations in, 287
Activity terms of trade for, 27
and inflation, 12, 118 Commodity prices
fluctuations in, 272, 301 fall in, 50
in EMDEs, 19 large shocks in, 17
inflation and, 19 volatility in, 327
slowdown in, 261 Competition
Advanced economies in domestic markets, 297
central banks in, 61, 224 in product markets, 226, 276
countries in, 413
in the financial sector, 63
disinflation in, 20, 40 in the retail sector, 257
inflation expectations in, i.22, 34, 207,
Computable general equilibrium, 385
230
Consumer prices
inflation in, i.3, 6, 162, 337
core, i.14-i.15, 14, 101
inflation targets of, 356
exchange rate and, 279
inflation variation in, 121, 143, 338
global, 5
inflation volatility in, i.11, 5, 53
in EMDEs, 278
Consumer price index
B
and producer price index, 17-18, 33,
Bretton Woods fixed exchange rate system, 158
i.4, 19 core inflation, 16, 29, 325, 334, 366
Consumption basket, 59, 178
C CPI; see consumer price index
Crises
Capital account openness currency, 119, 143, 166-67, 250
global shocks and, 337-339 debt, 166-67, 280
inflation and, 41 global financial, 32, 257
trade openness and, 329 oil, 27
Capital inflows, 40, 255, 355 Current account deficits, 27, 287-89
Central banks
analytical capacity of, 353, 359 D
credibility, 71, 298
in EMDEs, i.19, 53, 228 Deflation
in LICs, i.26, 324, 335, 357 and activity, 12
independence and transparency, i.13, broad-based, i.17, 7, 28, 143
25, 230, 348, 408 countries in, 145
inflation targeting and, 224 disinflation versus, 16
measure of independence, 348 in advanced economies, 6
turnover, 348 in the United States, 68-70
CGE; see computable general equilibrium trend, i.31, 14, 32-33
426 INDEX OF TERMS I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
Disinflation appreciation in oil-exporting economies,

broad-based, i.17, 7, 28, 143 287
in advanced economies, 28, 40 depreciation and inflation, i.23, 289,
in EMDEs, 20 299
in the United States, 68-70 pass-through ratio, 271, 288, 302
trend, i.31, 14, 32-33 shocks, 167, 292, 334-35
Domestic prices Export
and government interventions, 379, 384 bans, 384-85
and global prices, 372, 380 prices, 297
Domestic shocks restrictions, 372, 380-81
demand, 166-69, 180, 286 External debt, 280
supply, 167, 174-75, 286
Droughts, 251, 386 F
DSGE; See dynamic stochastic general Factor-augmented vector autoregression,
equilibrium 150, 175, 186, 303
Dynamic stochastic general equilibrium, FAVAR; see factor-augmented vector
125 autoregression
Fear of floating, i.21, 300
E Financial openness, 39, 147
EAP; see East Asia and Pacific Fiscal
East Asia and Pacific, 414 dominance in LICs, 24
ECA; see Europe and Central Asia policy and space, 174
ECM; see error correction model Fixed exchange rate regimes
El Niño, 372, 384 Bretton Woods system, i.4, 19
EMDEs; see emerging market and in EMDEs, 44
developing economies Food
Emerging market and developing government policies related to, 381
economies price inflation, 29, 59
disinflation in, 20 security, 373, 384
excluding LICs, 24, 335, 413 Food prices
inflation expectations in, i.19-i.20, i.32, and poverty, i.27, 374, 385
205, 207, 218 domestic, i.29, 335, 382
inflation in, i.9-i.10, 5, 14, 169, 278 global, i.27, 373
inflation volatility in, 32 Foreign currency invoicing, i.32, 297
Energy inflation, 31, 324-27, 350, 364 Foreign exchange reserves, 251, 280
Energy prices, 16, 29, 113, 327
ERPTR; see exchange rate pass-through ratio G
Error correction model, 383, 394
Europe and Central Asia, 29, 45, 208 GDP deflator
Event study, 151, 185, 279-80 contribution of global factor to, 96, 114
Exchange rate measure of inflation, i.6, 16
appreciation in advanced economies, synchronization in, 116
280, 285 Global business cycles, i.17, 148, 185
I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S INDEX OF TERMS 427
Global disinflation, i.6, 15, 146, 148 Insulating policies, i.30, 373-74
Global inflation Interest rate
evolution of, i.7, 14, 19 and inflation, 61
synchronization, i.12, 93, 95, 103 monetary policy instrument, 61, 358
Global recession, i.17-i.18, 100, 147, 185 International assets and liabilities, i.6, 40
Global shocks International price discrimination, 274
demand, i.8, 153-55, 167-68 Investment
supply, 154-56, 168-69, 289, 291 and inflation, 17
on global inflation, 155-57 and output growth, i.11, 7, 17
to domestic inflation, i.17, 146-47, 163- in EMDEs, 19
65, 169-72 uncertainty and, 18
Global value chains, 38-39, 178, 296, 327
Gold standard, 15, 34-35 L
Government debt
and fiscal frameworks, 47 Labor market
and inflation, 49, 251 and product market, 50
Great inflation, 68, 103 flexibility, i.10, 50-51, 124
Great Moderation, 32, 146, 171 trends in, 50
LAC; see Latin America and the Caribbean
H Latin America and the Caribbean, 20-21,
121-23, 391
Headline inflation, 16, 28, 327 LICs; see low-income countries
High-inflation episode, 11, 47 Low-income countries
Household survey, 209, 396-97 central banks in, 335, 354
Hyperinflation, 23, 63 countries in, 414
inflation expectations in, i.26, 324, 334
I
inflation in, i.9 i.24, i.32, 23, 326, 352
Import price inflation, 101, 113 inflation variation in, i.28, 105, 327
Import tariffs, 380, 395
Impulse response function, 305, 331 M
Income
Maize prices, 374, 387-88
distribution, 375, 378
Middle East and North Africa, 181, 383
inequality and poverty, 55-56, 60
MIRAGRODEP model, 396
Inflation expectations, i.8, i.19, 34, 205-
MNA; see Middle East and North Africa
08, 218, 221
Monetary policy
Inflation persistence, 17, 43, 215
and financial market, 180, 259
Inflation target, i.9-i.10, 14, 227-30, 250,
254-56, 362 framework, i.5, 42, 296, 407
Inflation volatility, 17, 32-33, 327-28, 352 in the United States, 68
Institutions shocks, i.23, 160, 167, 278, 285
and inflation targeting, 42 transmission channel of, i.10, 24, 180,
228, 352
and pegged exchange rate regimes, 42
428 INDEX OF TERMS I N F L A T I O N: E V O L U T I O N , D R I V E R S , A N D P O L I C I E S
N Product market
and labor market, 50
Net food buyers, 374, 390 flexibility, 49-50
Nominal rigidities in prices, 16, 273
Nonlinearities R
between exchange rate and inflation,
280 Rice prices, 380-82, 386
between inflation and growth, 60 Risk management instruments, 392
between inflation and inequality, 63
in exchange rate pass-through, i.32 S
O Safety net programs, i.10, 372, 392

SAR; see South Asia
Oil price shocks SDGs; see Sustainable Development Goals
and domestic inflation, i.8, 161, 221 South Asia, 27, 32, 121
and global demand and supply, 146-47, SSA; see Sub-Saharan Africa
153 Stagflation, 27, 69-70
and global inflation, i.17, 157 Staple foods, i.29, 374
and pass-through, i.24, 291 Sub-Saharan Africa, 32, 181, 388
in domestic inflation, 177, 296 Sustainable Development Goals, 373
OLS; see ordinary least squares
Optimal inflation, 8, 357 T
Ordinary least squares, 189, 244, 325
Output Trade
and employment, 17, 60 terms of, 27, 375-77
gaps, 176 liberalization, 27
inflation volatility and, 17-18 openness, i.13, 37-38, 296-97, 329,
337-39
linkages with input, 96
policies, i.10, 383-84, 391
losses, 8, 70
Transition economies, 28, 42
synchronization of, i.14, 108
P U
Panel regression, 40, 219, 241 Unconventional monetary policy, 61, 216
Pass-through
factors of, 276 V
shock-specific, i.24, 277 Variance decomposition, 104, 152, 290,
Phillips curve, 35, 68, 176, 214, 232 334-35
Poverty and inequality, 55-56, 372 Volcker recession, 69-71
PPI; see producer price index
Price stability W
in monetary policy, 352, 356
and central bank credibility, i.24, 302 Wage indexation, 47-48
Producer price index, i.4, 6, 16-17, 107, Wheat prices, 383, 387
157-58
E merging market and developing economies, like advanced
economies, have experienced a remarkable decline in inflation over
the past half-century. Yet, research into this development has
focused almost exclusively on advanced economies. This book fills
that gap, providing the first comprehensive and systematic
analysis of inflation in emerging market and developing
economies. It examines how inflation has evolved and become
synchronized among economies; what drives inflation globally and
domestically; where inflation expectations have become
better-anchored; and how exchange rate fluctuations can pass
through to inflation. To reach its conclusions, the book employs
cutting edge empirical approaches. It also offers a rich dataset of
multiple measures of inflation for a virtually global sample of
countries over a half-century to spur further research into this
important topic.
Many emerging market economies experienced a remarkable decline in inflation rates

over the last two decades, after years of seemingly intractable high inflation. Ha,
Kose, and Ohnsorge offer the first book-length analysis of this remarkable
achievement, asking how it happened, what it tells us about best policy frameworks,
and whether it will endure. At a time when global financial conditions pose a challenge
to emerging-market currencies and monetary policies, this book is an essential guide
to the road ahead. All students of the global economy will want to read it carefully.
MAURICE OBSTFELD
Economic Counsellor and Director of Research
A remarkable resource for anyone interested in inflation in the modern world, clear
and easy to follow. This book is an order of magnitude more comprehensive than
anything else out there, not only in its country coverage, but in its exploration of all
the major issues and debates surrounding inflation. Curiously, most of the existing
academic literature has focused on advanced economies—which are also thoroughly
covered here—yet there is so much to be learned from the dramatic inflation decline
in emerging markets and low-income economies, including for design of advanced
economy institutions. Any student, academic researcher or policy economist who
wants to understand the big picture on world inflation, and when and where it might
surprise in the future, will find this book fascinating.
KENNETH ROGOFF
Thomas D. Cabot Professor of Public Policy
and Professor of Economics
Harvard University
Government
of Japan

Inflation in Emerging and Developing Economies: Evolution, Drivers, and Policies

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Inflation in Emerging and Developing Economies: Evolution, Drivers, and Policies

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http://www.worldbank.

Many emerging market economies experienced a remarkable decline in inflation

A remarkable resource for anyone interested in inflation in the modern world,

This is an important and timely contribution to our understanding of inflation

This is a truly monumental work, incorporating pathbreaking data collection, a

Rights and Permissions

ISBN (paper): 978-1-4648-1375-7

Cover design: Lauren Kaley Johnson, World Bank Group.

Library of Congress Cataloging-in-Publication Data has been requested.

Abbreviations .............................................................................................................. xix

Chapter Authors ......................................................................................................... xxi

Introduction ............................................................................................................... i.3

PART A Inflation: Global and Domestic Drivers

1 Inﬂation: Concepts, Evolution, and Correlates...................................................... 5

PART B Inflation: Expectations and Pass-Through

4 Inﬂation Expectations: Review and Evidence .................................................... 205

PART C Inflation: Low-Income Country Considerations

6 Inﬂation in Low-Income Countries................................................................... 323

PART A Inflation: Global and Domestic Drivers ....................................................... 3

Chapter 3 Sources of Inflation: Global and Domestic Drivers .................................. 143

PART B Inflation: Expectations and Pass-Through .................................................203

Introduction ....................................................................................................... 205

Chapter 5 Inflation and Exchange Rate Pass-Through ............................................. 271

PART C Inflation: Low-Income Country Considerations ........................................ 321

Appendix: Cross-Country Database of Inflation and Country Characteristics.......... 403

Index ........................................................................................................................ 425

Anna Ivanova, Deputy Division Chief, Western Hemisphere Department,

M. Ayhan Kose, Director, Development Prospects Group, World Bank

David Laborde, Senior Research Fellow, International Food Policy Research

Csilla Lakatos, Senior Economist, Development Prospects Group, World Bank

Hideaki Matsuoka, Economist, Development Prospects Group, World Bank

Peter J. Montiel, Professor of Economics, Williams College

Franziska Ohnsorge, Manager, Development Prospects Group, World Bank

Ugo Panizza, Professor of Economics, Graduate Institute of International and

Peter Pedroni, Professor of Economics, Williams College

Marc Stocker, Senior Economist, Development Prospects Group, World Bank

Filiz D. Unsal, Economist, Research Department, International Monetary Fund

Dana Vorisek, Senior Economist, Development Prospects Group, World Bank

Hakan Yilmazkuday, Associate Professor of Economics, Florida International

Bruce K. MacLaury (1981)

Mario Draghi (2016)

FIGURE 1 Evolution of inflation

C. Inflation in advanced economies and D. Inflation distribution in EMDEs

E. Inflation in LICs F. Inflation and inflation volatility

than earlier work, which relied predominantly on advanced economy data.

• Use of cutting-edge methodologies. The study examines EMDE inflation

Why does inflation matter?

Key findings and policy messages

Low inflation: Here to stay?

Global inflation cycle: Learning to live with it

For policy makers, these observations suggest an increasing urgency to build

Anchoring inflation expectations: Better but not enough

Long-term inflation expectations have declined and become more firmly

Exchange rate pass-through: Amplification mechanism

These findings underscore the importance of understanding the underlying

Inflation in LICs: Challenges abound

A nuanced policy approach is necessary to mitigate the impact of global food

Part A. Global and Domestic Drivers

• How does inflation support or hinder economic activity?

• What factors have contributed to these trends in global inflation?

Chapter 2. Understanding Global Inflation Synchronization

• How has inflation synchronization among countries around the world

• What country characteristics have been associated with greater inflation